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Home  Arizona Law  Types of Entities Arizona S Corporation

Arizona S Corporation

by Richard Keyt

This article is part of a series of nine related articles about the seven types of entities most commonly used in Arizona to operate a business and to hold business assets.  The articles are:  sole proprietorships, general partnerships, limited partnerships, C corporations, S corporations, trusts, limited liability companies, the "best" entity and the entity comparison table.  The type of entity can have significant income tax and asset protection consequences.  The articles discuss the entities in terms of ease and cost of formation, number of owners & restrictions on ownership, privacy, control and management, owners protection from liabilities of the entity, and federal income taxation issues.

S Corporation

Ease of Formation & Cost

An S corporation is formed in Arizona exactly the same way as a C corporation, except that after formation, the stockholders of the corporation file an election with the IRS to have the corporation be taxed under Subchapter S of the Internal Revenue Code of 1986.  See the discussion above on the ease and cost of forming a C corporation.

Number of Owners & Restrictions

A corporation may not be an S corporation if it has more than 100 shareholders.  A husband and wife (and their estates) are treated as one stockholder.  All stockholders must be individuals, estates, exempt organizations described in Internal Revenue Code Sections 401(a) or 501(c)(3) or certain trusts described in Section 1361(c)(2)(A).  No stockholder can be a nonresident alien.  The corporation must not have more than one class of stock.  The corporation must have a tax year end of December 31 unless a different year end was approved by the IRS.  Every shareholder of a corporation (including spouses with community property interests) that seeks to be an S corporation must consent in writing on Form 2553 to adopting S corporation status.

Control & Management

Stockholders own a corporation, but the Board of Directors is responsible for managing the corporation.  The stockholders elect the members of the Board of Directors at the annual meeting of stockholders.  The officers of a corporation are responsible for the day-to-day operations of the corporation, and they report to and serve under the guidance of the Board of Directors. 

A corporation has the most on going and expensive maintenance requirements of any Arizona entity.  Arizona law requires that the stockholders hold an annual meeting. Directors should meet as often as necessary to manage the corporation and oversee the officers, but not less than once a year.  Meetings of stockholders and directors must be called by giving proper notice pursuant to the procedures set forth in the Bylaws of the corporation.  A quorum at each meeting is necessary to conduct a meeting and to approve any action.  All meetings of directors and officers should be documented with written minutes signed by the appropriate people.  Minutes and adopted resolutions should be kept in a minute book.

Arizona corporations must have a statutory agent, file an annual report with the ACC and pay a $45 fee.  If the annual report is not filed timely, the ACC assesses a penalty and will eventually revoke the charter of a corporation that does not file its annual report.

Privacy

Every year an Arizona corporation must file an annual report with the Arizona Corporation Commission.  The annual report must state the names and addresses of all: (i) stockholders that own 20% or more of the stock, (ii) the directors, and (iii) the officers.  This information is a matter of public record available on the ACC's website.

Owner's Protection from Liabilities

The general rule is that the stockholders, officers and directors of a corporation are not liable for the corporation's obligations and liabilities.  There are exceptions to this general rule such as directors may be liable for authorizing improper or illegal conduct.

There is a legal concept called "piercing the corporate veil," which is the term given when a court disregards the corporate shield that normally protects stockholders from liability and imposes liability on one or more stockholders.  When a court pierces the corporate veil, it is usually because the stockholders, officers and directors have not followed the formalities of operating in the corporate form.  The risk of having the corporate veil pierced is why it is very important that corporations hold properly called and documented annual and special meetings of stockholders and directors and that they file their annual reports and pay the filing fee timely.

Federal Income Taxation

The only reason stockholders elect to be taxed as an S corporation is to have an entity that, as a general rule, is not a taxpaying entity for federal income tax purposes.  An S corporation is taxed for federal income tax purposes like a partnership. 

An S corporation may owe income tax in the following instances:

1. If, at the end of any tax year, the corporation had accumulated earnings and profits, and its passive investment income under section 1362(d)(3) is more than 25% of its gross receipts, the corporation may owe tax on its excess net passive income.

2. A corporation with net recognized built-in gain (as defined in section 1374(d)(2)) may owe tax on its built-in gains.

3. A corporation that claimed investment credit before its first year as an S corporation will be liable for any investment credit recapture tax.

4. A corporation that used the LIFO inventory method for the year immediately preceding its first year as an S corporation may owe an additional tax due to LIFO recapture.

The  profits and losses of the S corporation are passed through to its stockholders pro rata based on each partner's percentage ownership of stock.  For example, if two people own 25% and 75%, respectively, of the stock of an S corporation and the S corporation has $100 of profit at the end of the year, the profit is allocated $25 to the 25% stockholder and $75 to the 75% stockholder.  Stockholders must include S corporation tax items on their personal federal income tax returns. 

Unlike a partnership or a limited liability company, the stockholders cannot agree to make special allocations among them of tax items such as profits and losses.  If a special allocation of profits, losses or other tax items is important to any potential stockholder, the stockholder should consider forming an Arizona limited liability company instead of a corporation.

Although an S corporation is not usually a taxpaying entity for federal income tax purposes, it must file an in informational tax return on IRS Form 1120S to notify the IRS of its profits, losses and other tax significant items.  For more information on the federal income taxation of partnerships, see IRS Publication 542, Corporations.

Related Articles

This article is a general discussion of the characteristics of S corporations.  The article is not specific advice.  Before choosing your new entity, you should consult with your accountant and business attorney and discuss your options and choose the type of entity that is best for you in light of your particular facts and circumstances. 

About the Author

Richard Keyt, J.D., LL.M. (income taxation New York University Law School) is a business, real estate, transactions, contracts and estate planning attorney licensed to practice law in Arizona.  He has formed over 1,500+ Arizona limited liability companies in the last few years because his low cost high quality LLC package is second to none and it only costs $599 for everything.  Rick has practiced law in Arizona since 1980.  Rick can be reached by telephone at 602-906-4953, ext. 101.  Email at  rickkeyt@keytlaw.com and fax at 602-297-6890.  Rick's web site located at www.keytlaw.com had over 1,000,000 visitors in 2006 and 2007.  Rick does not accept matters involving landlord / tenant disputes or litigation of any kind (other than tax lien foreclosures).  Communicating with Richard Keyt via email or otherwise does not cause you to become a client or cause your communications to be confidential or subject to the attorney client privilege.

This page was last modified on October 18, 2007.

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