Requirements for a company to be treated as a S Corporation

Requirements for a company to be treated as a S Corporation

'S-type corporations' are a special type of corporation that are designed to avoid the inconvenience of double taxation that impacts regular Type C corporations. 'S Corporations' allow profits and some losses to be transferred directly to the owners' personal income without being subject to corporate tax rates.

For the purposes of the IRS (Internal Revenue Service) taxes applied to S-type corporations are similar to those applied to personal companies (Partnerships). Similar to partnerships, the income, deductions and tax credits of a type S corporation are transferred to shareholders annually. Therefore, profits are taxed at the shareholder level and not at the corporate level.

See also: Advantages of a S Corporation

For a company to be treated as an S Corporation, the IRS 2553  Form must be completed, and certain requirements must be met:

I. The company must be a domestic corporation or entity.

II. You can't have more than 100 shareholders. You can treat an individual and his or her spouse (and their assets) as a shareholder for this condition. You can also treat all members of a family and their assets as a shareholder for this condition.

III. Your shareholders must be individuals, assets, some exempt organizations or certain trusts.

IV. The corporation can have only one class of shares

V. You may not have foreign shareholders who are not U.S. tax residents (non-resident aliens). We will take a break on this point to further explain how to determine whether you or any shareholder is a U.S. tax resident.

  • If you are a foreigner (not a U.S. citizen), you are considered a non-resident alien unless you meet one of two conditions: having a Green Card or the Substantial Presence condition for the calendar year (January 1 to December 31).
    • Green Card: You will be considered a resident, for the purposes of U.S. federal taxes, If you are a lawful permanent resident of the United States at any time during the calendar year, this is valid if you have been granted the privilege, in accordance with immigration laws, to reside permanently in the United States as an immigrant. You generally obtain this status if the U.S. Citizenship and Immigration Service (USCIS) issued you a foreign registration card, Form I-551, also known as a Green Card.
    • Substantial Presence: You will be considered a U.S. tax resident if you meet the substantial presence requirement during the calendar year. To meet this condition, you must: 1) be present in the country for at least 31 days during this year, and 2) Have spent 183 days during the last 3 years in the country, including the current year. You must use the following formula to count these days:

a) Every day you were present during the current year

b) 1/3 of the days that you were present the year before the current year.

c) 1/6 of the days you were present in the second year prior to the current year.

You must add these values and if the result is greater than 183, you will be considered as a U.S. tax resident. We invite you to visit this IRS website where these conditions are explained in more detail:

VI. The corporation must be a corporation eligible for this distinction, it cannot be:

  • A bank or savings institution that uses the reserve method to account for bad debts under section 585.
  • An insurance company subject to tax under subchapter L of the Code.
  • A corporation that has chosen to be treated as a holding corporation under section 936.
  • A National International Sales Corporation (DISC)

We recommend that you review the IRS publication: Instructions for Form 2553. This publication describes in greater detail all the requirements and conditions that a company must meet in order to qualify as a S-Corp. You can also visit this IRS publication, where you find general information about S Corporations.