2. Entity Choice: S Corporations  Legally a corporation under state law.  An S Corporation is a flow-through entity for tax purposes.  Income and loss items are allocated among shareholders based on their % ownership of stock (this allocation is not flexible like partnership agreements).  Flow-through items retain their character on the individual tax return (e.g. ordinary income core operations, and separately stated capital losses, charitable contributions, etc) just like for partnerships.

3. S Corporation Eligibility – Many Restrictions  Only individuals, estates and some trusts may be shareholders (no corporations or partnerships).  The number of shareholders (not including spouses & family) is limited to 100 all of whom must be US citizens or residents.  The corporation must be domestic and may only have one class of outstanding common stock.  Can be both voting and non-voting to aid succession planning  Shareholders elect S Corp status on Form 2553.

4. S Corporation Operation  Owners/shareholders can be paid a salary.  Salary is subject to payroll taxes and reduces ordinary income of the S Corporation.  S Corp can use corporate employee benefit plans for shareholder/employees.  Share of ordinary income is NOT subject to Self- Employment tax → HUGE advantage given 15.3% rate.  Allocable share of loss items can only be deducted up to BASIS, like with partnerships. Losses in excess of basis are carried over (suspended) until the shareholder has basis again.

5. Entity Choice: Partnership versus S Corporation?  S Corps require an IRS election, incorporation documents, possible corporate state tax payments.  Partnership agreements have more flexibility, but require more careful legal drafting.  Partners (but not S Corp shareholders) receive tax basis for general liabilities of the partnership.  Means partners can absorb more losses  S Corporation distributive share not subject to SE tax!  S Corp shareholders can be employees, while partners cannot; thus, benefit planning favors S Corps.