Managing an S-Corporation

Enjoy the tax benefits but make sure you keep good records

By Cherie L. Berkley, Owner, Legacy Letters, LLC

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:

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

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.
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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.
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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.
Try: 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.
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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.