Many corporations elect to be taxed under Subchapter S of the federal tax law to avoid (for the most part) the imposition of federal income taxes at the corporate level. When a valid S election is in place, the company allocates its income, losses, deductions, and credits among its shareholders, who take these items into account on their individual returns.

The IRS can terminate a corporation’s S election if requirements for the election are not met on a continuing basis:

• There can’t be more than 100 shareholders. Certain related individuals (e.g., a husband and wife) are counted as one shareholder.

• All shareholders generally must be individuals, estates, certain trusts, or tax-exempt 501(c)(3) charitable organizations. However, an S corporation can be wholly owned by another S corporation, and a partnership can hold S corporation stock as a nominee for an eligible shareholder.

• The corporation may not have a nonresident alien shareholder.

• The corporation may have only one class of stock. (Different voting rights are permitted, however.)