S corporations provide small-business owners with the limited liability protection of a regular corporation, without the double taxation of a regular corporation. Double taxation means a company pays taxes as an entity, and shareholders pay taxes on distributions received from the business. Under the Internal Revenue Code, an S corporation must adhere to certain restrictions on size and ownership.
An individual is allowed to invest in an S corporation. Individual shareholders of an S corporation must have U.S. citizenship or status as a resident alien. The Internal Revenue Service will revoke a company’s S corporation status if nonresident aliens or foreign individuals are allowed to invest in the business.
Also, an individual cannot invest in an S corporation if the company already has 100 shareholders. An S corporation that exceeds 100 shareholders is converted automatically into a regular corporation.
Certain estates and trusts are allowed to invest in an S corporation. However, other corporations, partnerships, limited liability companies and foreign businesses cannot invest in an S corporation. An S corporation that allows an LLC or corporation to invest in the business will be treated as a regular corporation. Furthermore, corporate subsidiaries are not allowed to invest in an S corporation, as explained by the Reference for Business website.
S corporations can issue only one class of stock. This means all investors in an S corporation receive distributions from the business at the same time as one another. Also, someone who invests in an S corporation receives the same price per share as the company’s other shareholders.
However, one investor in an S corporation may have different voting privileges than other shareholders, depending on the company’s bylaws.
Shareholders of an S corporation must report their share of company profits and losses on their individual tax return. People who invest in an S corporation must pay taxes on the company’s profits according to their personal income tax rate.
An S corporation does not pay taxes on the company’s profits and losses as a business entity. However, an S corporation must file an informational tax return, also known as Form 1120S, with the IRS. Form 1120S indicates each shareholder’s portion of the company’s profits and losses. The IRS uses this information to ensure that shareholders of the business are accurately reporting profits and losses from the business on their personal income tax return.