An S Corporation, or S Corp, is a form of corporation that meets the Internal Revenue Service's requirements to be taxed under Subchapter S of the IRS code. Basically this means that an S Corp pays no corporate income taxes on profits. The shareholders pay income taxes on their proportionate shares, called distributive shares, of the S Corp's profits. If you formed your small business under an S Corp, tax reasons likely fueled your decision. But now it's time to manage it properly in order to take advantage of those perks. Here are three requirements for retaining S Corp status:

1. There can be no more than 100 shareholders, and they must be U.S. citizens or residents.
2. The company must have only one class of stock.
3. Profits and losses must be allocated to shareholders proportionately to each one's interest in the business.

Action Steps
The best contacts and resources to help you get it done

Keep your house in order

Basic housekeeping is a must. S Corps must file articles of incorporation, hold directors and shareholders meetings and keep corporate minutes.

I recommend: Keep your investors updated about company news with Microsoft SharePoint Services. Use Microsoft Appointment Manager to schedule meetings.

Avoid audits

S Corps are often audited due to questions about salary and wages paid to officers in the corporation. Always show some compensation on IRS Form 1120S line 7 where it asks for 'Compensation of Officers.' The IRS assumes no one works for free. The salary must also be deemed a 'reasonable amount.' The same goes for salaries for nonshareholders. And yes, an owner-employee must draw a salary and pay payroll taxes.

I recommend: Check Monster.com or Salary.com to compare job salaries in the marketplace. ADP payroll services for Microsoft Office Small Business Accounting 2006 or QuickBooks can guide you through setting up a payroll and tax compliance.

Know the ins and outs of the tax code

Familiarize yourself with the S Corp's tax benefits. S Corps don't pay corporate taxes, but instead the IRS taxes business profits at individual tax rates on each shareholder's Form 1040.

I recommend: Find a good accountant to assist with your tax needs. The CPA Exchange can help.

Managing profits and losses

The IRS states that an S Corp generally passes gains and losses through to the shareholders based on their percentage of ownership.

I recommend: See instructions on IRS Form 1120S to learn how to calculate and report losses. Try Microsoft Money 2006 Small Business to track accounts, finances and invoices all in one place.

Tips & Tactics

Helpful advice for making the most of this Guide

• •  Shareholders must pay tax on profits regardless of whether the S Corp pays out money or not.
• •  To be safe, if you have multiple shareholders, create a shareholder agreement that prohibits them from doing anything that terminates the Subchapter S status.
• •  Nonresident aliens, C Corporations, partnerships and foreign trusts are ineligible to be S Corp shareholders.
• •  The IRS suggests that S Corps keep records for as long as they may be needed for the administration of any provision of the IRS code. Also, keep copies of all filed returns.
• •  Multiple members of one family can count as one shareholder.