USA S Corporation Formation

The eligibility conditions

• No more than one hundred shareholders
• Shareholders must be individuals, certain trusts or estates — not corporations or partnerships
• Shareholders must be US citizens or resident aliens; non-resident aliens are excluded
• Only one class of stock is permitted
• The entity must be a domestic corporation
• The election must be filed on Form 2553 within the prescribed time

Why the single class of stock rule matters

An S corporation may issue only one class of stock, which rules out the preferred shares venture investors expect. Differences in voting rights are permitted, but differences in distribution or liquidation rights are not.

That makes an S corporation unsuitable for a company intending to raise institutional money. A business that later takes venture funding will have to revoke or lose the election, which happens automatically if an ineligible shareholder acquires stock.

When it fits

It suits a US-resident owner-operated business with modest profits, where the pass-through treatment avoids the double taxation of a C corporation and the shareholder can take a reasonable salary with the balance distributed.

For an Indian founder without US residence, an LLC or a C corporation is almost always the right structure instead, and we will say so rather than pursuing an election that will not stand.

The Indian side is unchanged

• Forming any overseas entity is an overseas direct investment requiring reporting through your authorised dealer bank
• The foreign entity must be disclosed in Schedule FA of your Indian return
• An Annual Performance Report is due for the overseas entity each year
• Omission of foreign assets carries consequences under the black money legislation

How we handle it

1. 1 Testing eligibility We check shareholder residence status first, because a non-resident shareholder makes the election unavailable and the rest of the work pointless.
2. 2 Incorporation The corporation is formed in the chosen state with a registered agent appointed.
3. 3 Tax identification The Employer Identification Number is obtained, which the election requires.
4. 4 Filing the election Form 2553 is filed within the prescribed window, signed by every shareholder.
5. 5 Ongoing compliance Payroll for the owner-employee and the annual return are set up, since a reasonable salary is a requirement rather than a choice.
6. 6 Indian reporting The overseas investment is reported and flagged for Schedule FA disclosure.

Frequently asked questions