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S Corps: A Definition

An S corporation is a small business corporation for which an election to be taxed under Subchapter S of the code is in effect for the year. (Code Sec. 1361(a)(1)) A C corporation is a corporation that isn’t an S corporation for that year. (Code Sec. 1361(a)(2)) Except as otherwise provided in the Code, or to the extent inconsistent with the Subchapter S rules, the Subchapter C rules for the recognition of gain or loss on corporate organizations, reorganizations, distributions, insolvency reorganizations, liquidations, etc., apply to an S corporation and its shareholders. (Code Sec. 1371(a))

An S corporation may not have more than one class of stock. (Code Sec. 1361(b)(1)(D)) Straight debt is not treated as a second class of stock. Straight debt is a “written unconditional obligation,” whether or not contained “in a formal note, to pay a certain sum on demand, or on a specified due date.” The obligation may “not provide for an interest rate or payment dates that are contingent on profits, the borrower’s discretion, the payment of dividends” on the corporation’s “common stock, or similar” factors. In addition, to be straight debt, an obligation may not be “convertible (directly or indirectly) into stock or any other equity interest of the S corporation” and must be “held by an individual (other than a nonresident alien), an estate,” a trust that is eligible to be an S corporation shareholder or entities (i.e., not individuals) that are actively and regularly engaged in the business of lending money. (Code Sec. 1361(c)(5))

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The law firm of Ronald J. Cappuccio, J.D., LL.M. (Tax) provides answers and the legal advice you need to make sound decisions about your business entity. Call 856-665-2121 or text 856-745-4330 or send an email to make arrangements for a consultation.