Opinion ID: 768669
Heading Depth: 2
Heading Rank: 1

Heading: S Corporations

Text: 100 Subchapter S of the Internal Revenue Code was enacted in 1958 to encourage small businesses to adopt the corporate form. See Bufferd v. Comissioner, 506 U.S. 523, 525 (1993). The statute accomplishes this goal by means of a pass through system under which corporate income, losses, deductions, and credits are attributed to the individual shareholders in a manner akin to the tax treatment of partnerships. The tax advantage of an S Corporation is that it avoids the double taxation of corporate earnings to which shareholders of ordinary corporations are subject. See 26 U.S.C. §§ 1366 1368. Under the law applicable in 1992, to qualify as an S Corporation, a company must: (1) have no more than 35 shareholders; (2) have only one class of stock with identical rights to distribution and liquidation proceeds; and (3) distribute its profits and losses to its shareholders on a pro rata basis. See 26 U.S.C. §§ 1361(b)(1)(A); 1366(a)(1)(A). 101 A small business indicates its decision to become an S Corporation by filing a completed IRS Form 2553. See 26 C.F.R. § 1.1362 6(a)(2). An initial election to become an S Corporation is valid only if all persons who are shareholders . . . on the day on which such election is made consent to such an election. 26 U.S.C. § 1362(a)(2). However, once a valid election is made, new shareholders need not consent to that election. 26 C.F.R. § 1.1362 6(a)(2). 3 102 Every year, an S Corporation must file an informational return, reporting, inter alia, its gross income and deductions etc. See 26 U.S.C. 6037(a). Those who are the beneficiaries of income from the corporation must then pay taxes on that income on a personal basis, see 26 U.S.C. § 1366(c), regardless of whether the income is actually distributed. See id.; Hume v. Commissioner, 56 T.C.M. (CCH) 290, 293 (T.C. 1988), aff'd. 899 F.2d 1225 (9th Cir. 1990); see also Knott v. Commissioner, 62 T.C.M. (CCH) 287 (1991). The fact that undistributed income may be taxed explains the rule requiring unanimous initial consent to an S Corporation election. That rule ensures that no person who is the beneficial recipient of an S Corporation's undistributed income will be forced to report that income involuntarily. See Kean v. Commissioner, 469 F.2d 1183, 1186 (9th Cir. 1972). 103