A very important financial decision for Humboldt County corporations is whether to elect federal income tax treatment under IRC subchapter S. S-Corporation treatment is similar (but not identical) to partnership treatment. All the corporation’s shareholders are bound by an election into a S-Corporation. A S election has the effect of making the corporation a pass-through entity for federal and California tax purposes, but it does not change the nature of the business as a corporation for state corporate law purposes.
Similar to a partnership, the income and losses of a S-Corporation generally flow through to shareholders, and taxes are paid and/or deductions are taken by the shareholders. Following are some but not all of the requirements that must be met to qualify as a S-Corporation:
The corporation must have 100 or fewer shareholders. A husband and wife are treated as a single shareholder.
- The shareholders must be of a certain type. They include: 1) individuals who are United States citizens, or resident aliens in the United States, 2) an estate, 3) a Trust that meets certain requirements , or 4) a qualified Sub Chapter S Trust.
- The corporation must not have more than one class of stock, and corporations, partnerships and limited liability companies may not be shareholders in a S-Corporation.
- The corporation must be a domestic corporation, however, it may not be an insurance company nor a financial institution that uses the reserved method of accounting for bad debts.
A corporation that does not initially elect S-Corporation treatment may make the election for a later taxable year. A corporation that has elected to be a S-Corporation for a given year, may revoke its election by a vote of more than half of the shares.
A S-Corporation is often desirable when it is expected that the business will make a profit soon after incorporation, there will be little need to re-invest earnings into the business for expansion and/or the corporation will probably pay most of its net earnings to shareholders as dividends. A S-Corporation treatment may be desirable here because it avoids the double taxation problem.
Conversely, S-Corporation status may be undesirable if during the start-up period losses are expected that will be significantly larger than the shareholders’ tax bases in the corporation.
If you are considering incorporating in Northern California, including Humboldt, Del Norte, Trinity and Mendocino counties or if you have an existing corporation and need advice on whether or not to elect into a S-Corporation, please contact us.