Forming A Minnesota Limited Liability Company – Special Types Of Business Organizations

Special Types Of Business Organizations

S Corporations

Both “S” and “C” corporations are created by filing articles of incorporation with the Secretary of State, after which the shareholders must decide whether to treat the corporation as an S corporation or as a C corporation for tax purposes. An S corporation is a corporation which meets Internal Revenue Service criteria for tax treatment as an S corporation rather than as a C corporation, and whose shareholders unanimously choose to be so treated. An S corporation is taxed under Subchapter S of the Internal Revenue Code, whereas C corporations are taxed under Subchapter C of the Internal Revenue Code. A corporation that has a valid election to be taxed as an S corporation for federal purposes is also an S corporation for Minnesota tax purposes.

The S corporation is taxed in much the same manner as a partnership, i.e., the S corporation files an information tax return, Form 1120S, to report its income and expenses, but it is not separately taxed. Income (including, if certain requirements are met, capital gains) and expenses of the S corporation flow through to the shareholders in proportion to their shareholdings, and profits are taxed to the shareholders at the shareholders’ individual tax rates. For Minnesota purposes, the S corporation also pays a minimum fee, based on its Minnesota-sourced property, payroll and sales. See the Tax Rates section of this Guide.

By contrast, the C corporation is a separate taxable entity. The C corporation reports its income and expenses on a corporation income tax return and is taxed on its profits at corporation income tax rates. Profits are taxed to the C corporation before dividends are paid. Dividends, when paid, are taxed to shareholders who then report them as income. This results in double taxation of profits which are paid as dividends. By choosing S corporation status, this double taxation of corporate profits can be avoided.

An S corporation is defined by statute as a domestic corporation (i.e., a corporation organized under the law of one of the states of the United States) which:

  • Does not have more than 100 shareholders;
  • Does not have any non-individual shareholders (other than estates, certain trusts, and certain tax exempt entities);
  • Does not have a nonresident alien as a shareholder, and
  • Does not have more than one class of stock.

Certain corporations by statute are ineligible for S corporation status. If the corporation qualifies for S corporation status, the shareholders must formally choose to be so treated for tax purposes. This is accomplished by filing Form 2553 with the Internal Revenue Service on which all shareholders consent in writing to have the corporation treated as an S corporation. The election must be made in a timely manner, as prescribed by the Internal Revenue Service.

The election is valid for the taxable year for which it is made, and for all succeeding taxable years of the corporation, until the election is terminated. Statutory procedures determine how the termination is accomplished. In general, S corporation status is terminated when it is revoked by vote of the shareholders, or when the corporation no longer meets the statutory criteria for S corporation status. S corporation status also may be terminated when passive investment income (income from interest, rents, royalties, dividends and the like) exceeds a certain statutorily defined threshold.

Because of the possibility that S corporation status may be inadvertently terminated, persons planning to establish an S corporation are strongly encouraged to consult in advance with legal and tax counsel in order to properly structure the corporation and its capitalization. In some cases, formation of a limited liability company, rather than an S corporation, may better suit the owners’ business and tax objectives. See the discussion of limited liability companies in the sections of this Guide titled Choosing the Form of Business Organization and Forming a Minnesota Limited Liability Company.

This post is part of a series of posts on forming a limited liability corporation.

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