S Corporation

As an alternative to the ordinary "C corporation" discussed on the Corporation page, you may carry on your online publishing activities as an "S corporation." An S corporation has the same basic organizational structure as a C corporation, with some of the potential tax advantages of a partnership. A corporation obtains "S" status by filing Form 2553 with the IRS. An S corporation generally does not pay federal income tax at the entity level, except for tax on certain capital gains and passive income. Instead, the corporation's profits and losses "pass through" to shareholders, and profits are taxed at individual rates on each shareholder's Form 1040. However, an S corporation must file an annual tax return on Form 1120S with the IRS.

S corporations are formed in the same way as C corporations, but with the "S" tax designation filed with the IRS via form 2553 within two-and-a-half months of the date of formation. Federal law imposes certain requirements on a corporation in order to qualify for "S" status: (1) the corporation may have no more than 100 shareholders; (2) all shareholders must be individuals, estates, or certain trusts (i.e., no corporations, LLCs, or partnerships); (3) no shareholder may be a nonresident alien; and (4) the corporation may only have one class of stock. There are additional requirements, which you can learn about by reading the Instructions for Form 2553.

Your election of "S" status for federal tax purposes does not guarantee that the profits of your S corporation will not be taxed at the state level. The District of Columbia, for example, does not recognize "S" status and subjects the profits of S corporations to the ordinary state corporate income tax. Other states, such as California and Illinois, still tax the profits of S corporations, but at much lower rates than for C corporations. You can find more information about your state's tax laws in the state pages on forming a corporation.

S corporations generally are preferable to C corporations for small businesses because they require basically the same amount of paperwork, but may incur less tax than a C corporation. One drawback of an S corporation, when compared to a partnership or LLC (which have the same potential tax benefits as S corporations), comes with the inflexibility of profit distribution. With an S corporation, profit distributions must be pro rata to stock ownership, not practical contribution to the success of the business or any other relevant criteria. Thus, if a person owns 10% of the company, but does 90% of the work, he or she may only be allocated 10% of the profits. (Keep in mind, however, that this person could be compensated for work through a salary.) Another drawback is that S corporations are generally subject to the same operating formalities required of ordinary corporations, and this makes them a somewhat costlier and more cumbersome option than an LLC or partnership. For details, see the Corporation section.


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