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S Corporations

S Corporation Definition:  A Subchapter S Corporation provides the same limited liability to shareholders, directors and employee as a C Corporation.  However, a S Corporation allows corporate profits to be passed through directly to owners, without being taxed at the corporate level.

 

Limiting Personal Liability:  A S Corporation, like a C Corporation, protects owners, directors and employee from exposure to the liabilities, debts and obligations incurred by their business.  In many states, one person may own all the stock in a S Corporation and act as the corporation's only employee while still maintaining protection from personal liability.

Exceptions to limited liability protection:

1. A corporation takes out a loan, and someone within the corporation personally guarantees the loan.  Such personal guarantees are usually required when a corporation is undercapitalized and/or has not established a credit history.
2. State and federal governments can hold the corporate employee who is responsible for reporting and paying corporate taxes personally liable for unpaid taxes or penalties that come as a result of not paying taxes.  Normally, the party burdened with personal liability is the corporate Treasurer.
3. Members of a C Corporation can be found personally liable for breach of duty that they owe to the corporation.  Directors and officers have a "duty of care" to act responsibly when performing corporate duties.  Generally, if directors and officers attend meetings and carry out their responsibilities designated to them in the corporate bylaws, they will not be found in breach of their duty of care.

 

Piercing the Corporate Veil: In certain limited instances, creditors or litigants can attempt to impose personal liability on principals in a corporation by claiming that the corporation is a sham, a device created merely to defraud creditors, or is being run as a sole proprietorship (e.g., no shareholder's meetings or director's meetings have taken place; there has been a commingling of corporate and individual property).  The process of imposing individual and personal liability is referred to as "piercing the corporate veil" or "disregarding the corporate entity."  Ordinarily, a party seeking to pierce the corporate veil will have a heavy burden in attempting to persuade the courts to disregard the corporate entity.

 

Directors:  The board of directors are representatives of the shareholders.  They make the important policy decisions of the company and elect the officers.  Most states require corporations to have the lesser of 1) three directors, or 2) directors equaling the number of shareholders in the corporation. 

Officers:  The officers manage the day to day operations of the corporation.  Generally, the first three officers of a corporation are the President, Treasurer and Secretary.  In many states, a for-profit S Corporation with one director may have one officer fill all three roles.

Meetings:  Traditional S Corporations must hold annual meetings of the board of directors, as well as annual shareholder meetings.  Corporate bylaws may be drafted to allow shareholders and/or directors to attend annual meetings by proxy.  

Shareholder Reports:  Depending on how the corporate bylaws are drafted, a S Corporation may need to issue annual reports to shareholders, updating them on the financials of the company as well as any other pertinent matters.

State Reports:  Most states require S Corporation to file annual (in some states biannual) reports with the state, updating the status of directors, officers, shareholders, and/or the corporation in general.

Most states require one of the following words, or an abbreviation thereof, to be included in the name of a S Corporation:

names	abbreviations
Corporation	Corp.
Incorporated	Inc.
Limited	Ltd.

Corporations can do business under additional fictitious names if they file for a "DBA" in their state or county.  (If you are interested in filing a DBA, please inquire when placing your order.)

When forming a corporation, the founders must determine how many shares the corporation will be authorized to issue.  For example, the founders may authorize the corporation to issue 1,000 share, but only actually issue 10 shares to the first owner.  This leaves the corporation with the flexibility to issue 990 more shares to future owners.  

Some states increase filing fees the greater the number of shares a corporation wishes to authorize.  Generally, a small to medium size corporation can maintain adequate flexibility and avoid an increase in fees by authorizing 1,000 shares.  Furthermore, if it becomes necessary to authorize more stock at a later date, the corporation can file to amend its Articles of Incorporation and increase the amount.

*Common stock in a S Corporation represents a percentage of ownership.  Common stock owners are generally entitled to their pro-rata share of corporate profits.

 

tax implications for an s corporation

A S Corporation is taxed like a partnership.  As mentioned above, profits flow through from the corporation directly to the shareholders.  However, the S Corporation must file an informal return that tells the government how much money the partnership earned or lost and how much profit or loss belongs to each partner.

Furthermore, many states impose a minimal Franchise Tax on S Corporations, usually around 1% or 2% of profits (See your home state page for tax rates, and minimum taxes).

Owners who are active participants in a S Corporation can deduct business losses against other income.  However, an active owner can deduct losses from a S Corporation only to extent of his investment or loans to the corporation.

If a S Corporation fails, shareholders who were active participants in the business can write off their stock purchase as an ordinary tax loss.  The loss can be used to offset ordinary income that the shareholder has from other sources.  For example, if a shareholder purchased 10 shares of a corporation for $10,000, and the shareholder looses that entire investment, he can use that loss to reduce by $10,000 the amount of salary income that would otherwise be subject to income tax.

 

business expenses

Day to day business expenses can be deducted under a S Corporation they same way they would be deducted under a C Corporation.  To be deductible, business expenses must conform with IRS guidelines and be kept separate from personal expenses.  It should be noted that S Corporations are only allowed medical expenses up to deduct 7.5% of adjusted gross income per year.

 

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