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Jack Falvey's Investor Education Briefs: What is a Subchapter S corporation, anyway?

By JACk FALVEY
May 20. 2018 10:39PM




The names and numbers of all the players are in the program. It can’t hurt to page through the financial rule book. There is no need to develop expertise in corporate law.

Many small businesses choose to operate under Subchapter S of Chapter 1 of the Internal Revenue Code. They are incorporated by states as all corporations are. They pay no federal corporate income taxes if they meet S corporation federal rules. Their profits or losses are passed through directly to their shareholders and must be treated as ordinary income by them annually.

S corporations are limited to 100 shareholders. They are not regulated or safeguarded by a stock exchange, and are essentially private investments. They are often family or employee controlled corporations with some outside investors.

Before you consider putting your money in a Subchapter S corporation, there are all kinds of questions you must ask yourself.

You need to know all about the other owners, the business, the marketplace, the product or service provided and, in the case of family control, the dynamic of that element. There are more legal ramifications, but these are the basics.

It well could be that you are born into or marry into an S corporation. So be it.

In that case you need to become an expert in the enterprise.

You may choose to start your own business in this form to seek funding from a small group.

If growth warrants, you have the option of becoming a C corporation under more common tax laws requiring the payment of federal corporate taxes.

Few will take this kind of an adventurous ride, but many may get a chance to work for an S corporation, so it is a good idea to at least ask how things are structured.

As far as putting cash into an S corporation, that is a call few make, or have the wherewithal to make. As with almost all investment decisions, “it all depends” becomes the operative phrase.

Who you are investing in at this level is of equal or greater importance than what you are investing in.

Sticking to public company investing and the mutual funds those public companies are combined into is where the personal or non-professional investor usually feels most comfortable.

Do S corporation investors sleep well?

Some do. Some don’t.

That makes the S easier to remember.

Jack Falvey is a frequent contributor to the Union Leader, Barron’s and The Wall Street Journal. He can be contacted at Jack@Falvey.org.


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