Businesses in the Chicago area that start out as sole proprietorships or partnerships often make the decision to incorporate. While there are many factors weighing in favor of doing business as a corporation, primary among them is the protection it affords its owners against personal liability for the debts and financial obligations of the business.
Corporations and S Corporations
As common as corporations have become, it remains a popular misconception that an S corporation is a form of corporation. A corporation formed under the laws of Illinois may file an election with the IRS for treatment for taxation purposes as a corporation under Subchapter S of the Internal Revenue Code.
The Issue of Double Taxation
A drawback for some business owners in making the switch to a corporate form of doing business is taxation. Sole proprietors and partnerships pass profits and losses through to the owners who report them on their personal income tax returns.
Corporations and their owners — the shareholders — each pay taxes on income generated from the business. The corporation files a corporate tax return and pays taxes on its profits. Profits that are then distributed to shareholders as dividends must be reported on the individual’s personal income tax return.
Benefit of a Subchapter S Election
A corporation that elects Subchapter S treatment passes its profits and losses through to the shareholders who include it on their personal income tax returns. The result is only one layer of corporate profits instead of two.
Forming a Corporation in Illinois
A Chicago business owner begins the process by forming a corporation according to the the process established by Illinois law, including the following:
- Select and reserve a name that ends with one of the following the words or an abbreviation: “incorporation,” “corporation,” “limited” or “company.”
- Prepare articles of incorporation and file them with the Illinois Secretary of State.
- The Secretary of State will return a copy of the filed articles of incorporation and a certificate of incorporation to the person setting up the corporation who will record them in the local Office of the Recorder of Deeds.
Making the Subchapter S Election
Once a corporation is formed in Illinois, it may file Form 2553 with the IRS to be taxed as an S corporation, provided it meets IRS guidelines including:
being incorporated in the United States
having no more than 100 shareholders and one class of stock
not having any partnerships, corporations or non-resident aliens as
Revocation and Termination of a Subchapter S Election
A corporation can revoke its election by sending a written notice to the IRS. The IRS may terminate an election if the corporation no longer meets the eligibility guidelines. A corporation cannot file another Form 2553 without IRS permission for five years after revocation or termination of an election.
Seeking Professional Advice
An attorney and accountant should be consulted to determine whether electing to be taxed as an S corporation is the best course of action for a business.