A special subtype of the incorporated entity is termed the "S Corporation" (formerly "Subchapter S" Corporation), again the name taken from the location of the governing provisions in the Code. For most purposes, S Corporations are garden-variety corporations under state law, the distinguishing factor being that if they configure themselves to meet special rules of the Internal Revenue Code, no corporate tax is assessed, thereby passing through corporate income and losses directly to the shareholders. Under the Tax Reform Act of 1986, S Corporations became increasingly popular because, for the first time since 1916, personal tax rates were lower than the corporate tax rates, thereby putting a premium on the ability of a business entity to pass through its income to its shareholders without the imposition of tax. Moreover, while losses from passive activities may not be offset against income other than from passive activity under the Tax Reform Act of 1986, losses garnered by an S Corporation and allocable to a shareholder who materially participates - as an officer, for example - in the S Corporation's business may elude the "passive activity" trap and thus be more widely useful. Such losses are, however, limited generally to the shareholder's tax basis in his stock and any loans he has made to the corporation.
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Author: Joseph W. Bartlett
