S Corp Shareholding
Whether you run an S Corporation or choose to invest in one, it is essential to keep a few key considerations in mind. The tax benefits gained from an S Corporation versus a C Corporation are crucial, and two main reasons for electing S Status are:
- Avoid double taxation on distributions
- Allow corporate losses to pass through to the owners (shareholders).
Another paramount difference is in the details surrounding shareholders. Shareholders in an S Corp must adhere to strict rules, as must the S corporation regarding its shareholders. These rules differ dramatically from the laissez-faire attitude characteristic of other types of stocks. Shareholders in an S Corporation, for instance, must be a US citizen, resident alien, or certain trusts and estates. S Corporations may only have one class of stock and are limited to 100 shareholders or less. Additional considerations taken into account are as follows.
Shareholders Required to Compute Basis
The amount of a shareholder’s stock and debt basis in the S Corporation is very important. As with many other stocks, the shareholder in an S Corporation gains an initial stock basis through the purchase of the stock. While the shareholder holds the stock, if further equity contributions are made it will increase the shareholder’s basis. The company’s cumulative net income then increases each shareholder’s basis according to their allocation of the pass through amounts (or if a loss, it will decrease the stock basis). The basis is also decreased by certain deductions and the payouts (distributions) made to the shareholder from the S Corporation. Typically, a distribution is tax-free to the extent it does not exceed the shareholder’s stock basis. A shareholder’s basis is vital when allocating a loss, deduction, or distribution to the shareholder because it shows the potential tax-deductible loss and determines whether the distribution is taxable or not.
Making the Determinations for Debt Basis
A debt basis can also be acquired through something all of us are familiar with: loans. Any loans made by a lender to the S Corporation provide the lender with a debt basis. Each year, a shareholder’s stock and debt basis will increase or decrease based on business operations. When you get down to it, two simple criteria need to be met to show a shareholder’s debt basis in an S Corporation. Firstly, there must be an unbroken line of capital flow directly from the shareholder to the S Corporation. This line is traceable and, according to the IRS, must meet the “bona fide debt” provisions. In simple terms, there must be a legal agreement for the company to repay a set amount of capital to the shareholder.
Work with our Small Business Specialists
Running your own business isn’t easy, and it certainly takes time, determination, and lots of hard work, however with the right tools and knowledge, it can be a lot easier. Alron Corps, Inc., a subsidiary of Alron Enterprises, Inc. specializes in providing small businesses the highest quality expert assistance. Contact us today to get started! We look forwarding to hearing from you. Give us a call: 321-951-7626 or send us an email: [email protected]
by Nick Climan – Content Creator at Half Full Marketing