S Corporation

S corporation are pass-through entities, their profits are taxed directly to the shareholders, who pay tax on it according to their individual income tax rates. Similarly losses pass through too, S corporation shareholders take most business operating losses on their individual returns. Some states like Delaware and Nevada have very low incorporation fees but keep in mind that California charges the same fees for qualifying as an out-of-state corporation as it does for creating a California corporation, therefore it is not advisable for California resident to form a Delaware corporation.
Often new enterprises elect S corporation status in the early years and when profitable convert to a C corporation.

Qualification for S Corporation

S Corporation is a U.S corporation with no more than 100 shareholders. All shareholders are individual U.S citizens or resident aliens or other S corporations, or an electing small business trust. The corporation has only one class of stocks. There can't be any preferred classes of shares.

Tax Reporting

Although an S corporation business is not a tax paying entity it is most definitely a tax reporting entity. S corporations must file an annual corporation tax returns. California corporations need to file state tax returns as well and need to pay a minimum annual franchise tax of $800 even if the corporation loses money.

At Kyrish CPA, Sunita Jagasia is a Certified Public Accountant with many years of experience filing corporate taxes. Corporation taxes are tricky and should always be professionally prepared.

An S corporation reports to the IRS each stockholders proportionate share of its profit (or loss) on annual IRS schedule K-1 forms. In addition S corporation must file and pay employment taxes on its employees.

Material Participation

As an S corporation shareholders, must materially participate in the business to deduct losses against other income. Merely being an investor in an S corporation doesn't cut it. If challenged by the IRS at an audit you should be prepared to show proof of material participation.

IRS auditors may question low S corporation owner salaries. It hasn't escaped the notice of the IRS that S corporation owners minimize their self-employment taxes by taking dividends.