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What is a Subchapter S Corporation?

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  • Written By: Matt Brady
  • Edited By: Jenn Walker
  • Last Modified Date: 29 October 2016
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In the United States (U.S.), a Subchapter S corporation, also known as an S corporation or an S corp, is a kind of small corporation that blends the advantages of a partnership and a corporation. This kind of corporation is named Subchapter S because it qualifies for being taxed under Subchapter S of the U.S. Internal Revenue Code. This allows a Subchapter S corporation to enjoy the federal tax benefits of a partnership while also enjoying the limited personal liability that protect corporations.

By qualifying for Subchapter S taxation, a Subchapter S corporation avoids having to pay the corporate tax that most other corporate structures must pay. Instead of being double taxed, once at the corporate level and then at the shareholder level, Subchapter S corporations are legally allowed to pay taxes only on shareholders' income. A business owner or shareholder under a Subchapter S structure may be able to retain significant profits by avoiding taxation at the corporate level. Another way of eliminating corporate taxation is to structure a business under a partnership, but this leaves a business without the limited liability benefits of a corporation, meaning that if a partnership went under or was being sued, the owners' personal assets could be targeted.

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Under a Subchapter S corporation, shareholders' personal assets are protected by the corporate structure, which exists as its own entity, but the shareholder is still free to enjoy all the tax benefits of a partnership. Some U.S. states have an equivalent tax plan for this kind of corporate structure as well, though rules and availability vary by state. As a result, professional financial and legal consultation is advised to help aid the process as well as to assess whether a Subchapter S classification is the right fit for a certain business.

The requirements listed to qualify as a Subchapter S corporation can be stringent. Generally, no more than 100 shareholders can be involved in the company. The shareholders must meet certain eligibility requirements, and there are also limits on what class of stock a Subchapter S corporation can issue. A business may initially structure itself under a Subchapter S classification, only to decide that its growth model isn’t suited for that kind of corporate structure. Fortunately, with some money and the right legal council, a business can easily transition to a different status of corporation if a Subchapter S status isn't the right fit. On the other hand, larger corporations with more than 100 shareholders may have a harder time converting into a Subchapter S structure.

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