Understanding S Corporations for CPA REG
S Corporations are a crucial topic for the CPA REG exam. They offer a unique tax structure that blends aspects of partnerships and C corporations. Mastering their formation, operations, and tax implications is vital for exam success.
What is an S Corporation?
An S corporation (or S corp) is a business entity that has made an election to be taxed under Subchapter S of the Internal Revenue Code. This election allows profits and losses to be passed through directly to the owners' personal income without being subject to corporate tax rates. This avoids the 'double taxation' often associated with C corporations.
Eligibility Requirements for S Corporation Status
To qualify as an S corporation, a business must meet several strict criteria set by the IRS. Failure to meet any of these requirements can result in the loss of S corp status.
| Requirement | Details |
|---|---|
| Domestic Corporation | Must be a U.S. domestic entity. |
| Shareholder Limit | No more than 100 shareholders. |
| Shareholder Type | Shareholders must be individuals, certain trusts, estates, or tax-exempt organizations. Partnerships and C corporations cannot be shareholders. |
| Residency | Shareholders generally must be U.S. citizens or resident aliens. |
| Classes of Stock | Only one class of stock is permitted, though differences in voting rights are allowed. |
Forming an S Corporation
Forming an S corporation involves two main steps: first, establishing a legal entity (like an LLC or C corp) with the state, and second, electing S corporation status with the IRS.
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The election is made by filing Form 2553, Election by a Small Business Corporation, with the IRS. This form must be signed by all shareholders and filed within a specific timeframe.
Taxation of S Corporations
The taxation of S corporations is complex and involves several key concepts that are frequently tested on the CPA exam.
Pass-through taxation, which avoids double taxation of profits.
Distributions vs. Salary
A critical distinction for S corps is how owner compensation is handled. Shareholders who actively work for the business must be paid a 'reasonable salary' as employees. Any remaining profits can be distributed as dividends.
Paying a reasonable salary is a key compliance requirement. The IRS scrutinizes this to ensure owners aren't avoiding payroll taxes by taking excessive distributions instead of salary.
The flow of income and distributions in an S corporation can be visualized. Income is allocated to shareholders based on their ownership percentage and increases their basis. Distributions reduce basis. Losses also reduce basis, but are limited by the shareholder's basis. This interplay of basis adjustments is central to S corp taxation.
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Termination of S Corporation Status
S corporation status can be terminated voluntarily or involuntarily. Involuntary termination occurs if the corporation violates any of the eligibility requirements. Voluntary termination requires a vote of the shareholders.
Form 2553, Election by a Small Business Corporation.
Key Concepts for the CPA Exam
For the CPA REG exam, focus on: shareholder basis calculations, the impact of income/loss/distributions on basis, reasonable salary requirements, and the rules for qualifying and maintaining S corp status. Understanding the differences between S corps and C corps, as well as S corps and partnerships, is also essential.
Learning Resources
The official IRS page provides foundational information on S corporations, including definitions, eligibility, and tax implications.
The official CPA Exam blueprints outline the content and skill areas tested, including detailed coverage of business law and taxation relevant to S corporations.
This resource offers a clear, accessible explanation of what S corporations are and their tax treatment, often with helpful comparisons.
A comprehensive guide from a major accounting firm, detailing the intricacies of S corporation taxation and compliance.
Provides a broad overview of S corporations, their advantages, disadvantages, and how they are taxed, suitable for foundational understanding.
Search for reputable CPA review course videos on S corp taxation. Many offer visual explanations of basis adjustments and distributions. (Note: Specific video URL is illustrative; actual search recommended).
Offers practical insights and explanations of S corporation fundamentals from a professional tax organization.
Access to the actual U.S. Internal Revenue Code sections pertaining to S corporations for in-depth legal and tax understanding.
Articles from the AICPA's flagship publication often cover current tax law changes and complex S corp scenarios relevant to CPAs.
Look for detailed video tutorials that walk through the step-by-step calculation of shareholder basis in an S corporation. (Note: Specific video URL is illustrative; actual search recommended).