Typically, the income of a corporation is taxed to the corporation itself. This can lead to double taxation. For instance, if you own all of the shares of a corporation, the corporation would be taxed at the corporate tax rate and then any distributions to you would be taxed as individual income.
This leads to the S Election. All of the owners of a corporation may make what is called an S Election with the IRS on Form 2553. In general, an S Election allows the income of an S corporation to be taxed to the company’s shareholders instead of the corporation.
There are multiple restrictions on S Elections, a couple of which are that you cannot have more than one class of shares, you can not have any foreign owners of the company and you must have less than 100 shareholders.
These are great points. Other limitations of S corporations are that they are: 1) limited to individual shareholders, and 2) they cannot be taken public.
For entrepreneurs considering venture capital, an S election is problematic as most VC's are institutional investors and do not fit the profile of an individual shareholder. Furthermore, lacking the ability to do an IPO takes away another alternative for a liquidity event.
Posted by: Aaron Woo | August 14, 2009 at 12:51 PM