Strictly speaking, “S” corporations and “C” corporations are not two different types of corporations – they are two different corporate taxation categories established by the IRS. S corporations are based on Subchapter S of the Internal Revenue Code, while C corporations are based on Subchapter C. It is possible in some instances to elect one status or the other.

Although the S corporation is popular due to its “pass-through” taxation status, legal restrictions on S corporations sometimes prevent companies from claiming it. It is important that you don’t attempt to convert your company to S corporation status until it is eligible, and that you properly complete all legal formalities. Failure to do so could result in a nasty tax surprise at a later date.  

The Primary Legal Restrictions on “S” Corporations

According to the Internal Revenue Code, an “S” corporation may not:

  • Be organized under the law of a foreign country;

  • Include partnerships with other corporations or non-resident aliens as shareholders;

  • Have more than 100 shareholders;

  • Offer more than one class of shares (disregarding differences in voting rights); or

  • Operate as certain types of financial institutions: an insurance agency, a possessions corporation, or a domestic international sales corporation.

Corporate Formalities

The process of electing S corporation status begins with a Board of Directors resolution to bring the issue of conversion before the general shareholders meeting. Once this resolution is passed and filed, the issue can be presented and voted upon at the shareholders meeting. Unanimous approval by the shareholders is required. Please note that unanimous approval is not required to revoke S corporation status.

IRS Notification

To formalize the company’s election, Form 2553 – Election by a Small Business Corporation, must be filed with the IRS. Form 2553 must be postmarked no later than the 15th day of the second month of the corporate tax year in which the election is to take effect. If the company’s tax year is the calendar year, for example, Form 2553 must be filed no later than February 15th of the year of conversion.

If Form 2553 is filed late, your company’s S corporation election won’t take effect until the following tax year. This could be disastrous if you proceed the remainder of the year under the false assumption that your company already enjoys pass-through taxation status. This is something that you absolutely must get right.

The LLC: A Popular Alternative

The Limited Liability Company (LLC) is a popular alternative to S corporation status. Although both of these business vehicles enjoy tax advantages, the particular advantages of each are beyond the scope of this article. LLCs do avoid many of the corporate formalities that S corporations must observe, however.  

Don’t Take this Decision Lightly

Deciding on your corporate form is not a decision to be taken lightly. At CKB Vienna LLP, we can help you explore the implications of this decision, including remote consequences that you might not have thought of.

Call us at 909-980-1040 or fill out our online contact form to schedule a consultation to learn how we can best assist you. We serve clients from all over Rancho Cucamonga including Alta Loma and Etiwanda, as well as clients from Upland, Fontana, Ontario, Chino Hills, and Claremont.

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