An S corporation is a type of corporate entity that provides special tax advantages to the shareholders of the company. Shareholders of an S corporation are allowed to pass their share of the company's profits and losses directly to their personal or joint income tax return. There are certain rules an S corporation must obey to maintain the company's status as an S corporation.
An S corporation can voluntarily revoke the company's status. A majority of the S corporation's shareholders must agree to the revocation of the company's status. The S corporation is required to notify the Internal Revenue Service in writing that the company wants to voluntarily revoke its corporate status. An S corporation may lose its status involuntarily by failing to comply with the regulations for operating the company. When this happens, the business automatically loses its status on the date of the infraction. An S corporation that loses its status will automatically be treated like a regular C corporation. Unlike an S corporation, a C corporation is subject to double taxation. The first tax happens because the company must pay taxes as a business. The second tax happens when dividends are issued to shareholders of the business. Shareholders of a C corporation must pay taxes on income received from the company on their personal income tax return.
An S corporation must adhere to certain size requirements to keep the company's status. An S corporation cannot have more than 100 shareholders participating as owners of the company. Corporations that exceed 100 shareholders will automatically lose their status as an S corporation and will be treated as a C corporation.
There are certain ownership restrictions that an S corporation must adhere to. Only individuals, certain estates and trusts are allowed to participate as owners of an S corporation. When another business entity such as a partnership or a corporation is allowed to become a shareholder of an S corporation, the company will automatically lose its status as an S corporation. Individuals who own shares of an S corporation must be citizens of the U.S. or resident aliens. Accepting foreign individuals as shareholders of the company will cause the business to lose its status as an S corporation.
S corporations that do not obey the rules regarding stock will have the company's status terminated. An S corporation may issue one class of stock to potential investors. When an S corporation decides to issue more than one class of stock, the business will have its S corporation status terminated.