Description of an S Corporation: The “S” in S Corporation designates it as a small business. This allows the corporation, which starts out as a C Corporation, to elect a special type of IRS tax election, an S Corporation (sometimes referred to as an S Corp, Subchapter S, or Sub S). This allows an eligible domestic corporation to avoid double taxation that a C Corporation pays. An S Corporation is limited to one type of stock. An S Corporation in Colorado is limited to 75 owners which are stockholders. Shareholders can consist of individuals, tax exempt organizations or certain allowable trusts, but do not allow non-resident alien shareholders.
Formation of an S Corporation: To form an S Corporation in Colorado the person creating the corporation would do so on the Colorado Secretary of State website. The formation will be a “for profit” organization, or basically filing as a C Corporation. Once filed, and assuming that the Corporation is eligible, the shareholders sign and file Form 2553, Election by a Small Business Corporation, with the Internal Revenue Service (IRS).
By-Laws for an S Corporation: A Bylaw is a rule or law established by a Corporation to regulate itself. When people refer to Bylaws of a Corporation they are generally talking about a document that was created as the set of rules or regulations by which the corporation will be controlled or regulated. They determine the rights of the stockholders and provide guidance to the board in how the business will be conducted. Bylaws are extremely important and should be written in a manner, that when followed, will protect the board of directors, officers and stockholders from personal liability. Legal requirements for what the Bylaws should contain vary by state.
S Corporation Taxes: One of the major drawbacks of operating as a Corporation (C Corp) is that there is double taxation, the corporation is taxed on its profits, then the stockholders are taxed on dividends. However, an S Corporation (S Corp) allows the profits and losses to pass through to the stockholders’ personal tax return. An S Corp is not taxed for its profits, but the tax liability is passed through to the stockholders, thus eliminating double taxation.
Because an S Corporation is generally a small corporation, the owners will have different rolls which may consist of being a shareholder, director and officer. Employee earnings are taxed at a higher rate than dividends. However, if a shareholder is also an employee, it is important that that person receive a reasonable salary or payment. If an employee/shareholder is paid too low of a salary, and makes too much in dividends the IRS may reclassify corporate earnings as salary or pay.