Corporations have rights and obligations independent of their owners, the shareholders. Like their individual owners, corporations can own property, sell and buy goods and services and pay taxes in their own names. However, the Internal Revenue Service classifies certain companies as "S Corporations," so that these entities, unlike regular, or "C Corporations," do not pay taxes or claim losses in their own name. Instead, only the shareholders face the tax benefits and burdens of the company's business activities.


S corporations may have up to 100 shareholders, with family members or spouses counting as one shareholder. These companies can have only one class of stock. However, a business does not automatically become an S corporation; it must choose the status by filing a Form 2553 with the Internal Revenue Service. Once it elects, a company does not lose its S corporation status until it gets more than 100 shareholders, has three straight years of profits and gets at least a fourth of its revenues from passive business activities, such as holding stocks or land; or gets owners holding at least half of the stock to decide to stop being treated as an S corporation.

Taxation of Profits

The profits of regular corporations are taxed twice. The company pays taxes on its earnings, and then the shareholders get taxed on any payments they receive out of the company's profits in the form of dividends. In an S corporation, the company does not pay taxes on the earnings. Instead, the income passes directly through the company to the shareholders, who report the earnings on their personal tax returns.

Deducting Losses

As with profits, the losses of an S corporation pass through the company to the shareholders. The company's owners can deduct most losses from their own income. However, deductions are limited to the shareholder's basis, or cost, of the company's shares. The shareholder can raise basis by her share of the company profits, money she contributes to the company or money she borrows to contribute to the company if she must repay the loan. Further, losses that result from activities in which the shareholder is not involved, such as owning property rentals or holding investments, can offset only income from these passive activities. Shareholders in C corporations do not deduct company losses, since the company is its own taxpaying entity.

Employee Stock Option Plans

An employee stock option plan allows the company's workers to share in the company's ownership. Unlike regular corporations, S corporations do not pay taxes on any profits attributed to the stock option plan. However, sellers cannot delay paying taxes on their sales to an S corporation stock option plan, while those who sell to a C corporation plan can. C corporations may reduce from taxable income the dividends, or payments from profits, on stocks from the plan if the company repays a plan loan or passes the dividend directly to the employees. Payments from profits of S corporations to employees are not deductible from taxable income.

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