AVOID DOUBLE TAXATION: DOES MY CORPORATION QUALIFY?

By Brandy M. Kumfer May 2013

Double taxation is a principle which refers to income taxes being paid twice on the same source of earned income. Double taxation exists in traditional C corporations because the corporation is deemed a separate entity from its shareholders. As a result, the corporation pays income tax on its annual earnings, and shareholders incur income-tax liability on dividends they receive, even though the earnings that provided the dividend were already taxed at the corporate level.

That said, double taxation is not the only option. One option that may be available to you is electing to be an "S corporation". The Internal Revenue Code provides that an entity may elect to be "S corporation" in certain circumstances:

  • Eligible C corporations: Not every C corporation is eligible to be an S corporation. There are shareholder requirements, a capitalization requirement, requirements for corporations with accumulated earnings and profits where the corporation has certain levels of passive income, and requirements relating to the corporation itself.

  • Shareholder requirements: An S corporation cannot have more than 100 shareholders. Only individuals who are U.S. citizens or residents, certain estates, certain trusts, and certain tax-exempt organizations can be shareholders of an S corporation.

  • Corporate requirements: Only domestic corporations can qualify for S status.

  • Electing S corporation status: The shareholders of a C corporation may elect S status and, in general, the corporation will avoid a corporate-level federal tax on its operating income or on gain resulting from the sale of its business. Items of income, deduction, gain, loss, and credit are generally taken into account only by the shareholders and not by the corporation in computing taxable income and tax.

  • Capitalization requirement: S status is available only to corporations with one class of stock outstanding (differences in voting rights among the shares of common stock do not violate the one class of stock requirement).

In many cases, the election of S corporation status does not create any major, immediate tax consequences. But, since, in general, the shareholders of an S corporation are taxable on the income of the S corporation, the tax-compliance burden may be increased. Each shareholder may be required to file individual tax returns and pay individual tax and estimated tax in each state in which the S corporation does business.

If your company is interested in reviewing its corporate structure, speaking with a business-tax professional will help you understand your circumstance and whether your business could qualify for S status. In each case, there are additional concerns that have to be address to determine whether or not electing to be an S corporation is appropriate. The attorneys of Allen Wellman McNew Harvey, LLP have extensive business and tax law experience and would be happy to consult with you regarding your corporate structure concerns.