The S corporation alternative could provide some business owners with a reduction in corporate liability, without forcing them to suffer the additional tax burdens of a regular corporation, but there are some restrictions.

The chief benefit of filing as an S corporation is that an S corporation generally pays no income tax at the corporate level. A traditional corporation pays tax on the company's income. In the case of an S corporation, the company's income is passed through to shareholders and taxed on their individual income tax returns. When the corporation pays out this income as dividends, the shareholders are obliged to pay taxes on their dividends.

However, the S corporation does have some disadvantages associated with it. Generally, S corporations need to file based on a calendar-year-end. Calendar-year corporations must file an election by March 15, 2003, in order to be treated as S corporations for 2003. Before an election is made, the effect on both the corporation and its individual shareholders needs to be considered. In addition, S corporations are limited to no more than 35 shareholders, and may be limited to only a single class of stock. What's more, S corporations cannot deduct the costs of certain fringe benefits. These include group life insurance and health insurance provided to their shareholder-employees who own more than two percent of the company's stock. These benefits are classified as distributions to the shareholders, and any deduction permitted is taken on the shareholders individual tax return.

C corporations contemplating a switch to S corporation status, should bear in mind that certain additional factors might cost them some money. These include the built-in gains tax and the treatment of carryover items like tax credits or losses.

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