Congress enacted the S corporation (originally called subchapter S corporation) rules in 1958 to minimize the role of tax considerations in the type of business form choice, to allow single-level (pass-through) taxation at the shareholder level, and to allow owners to offset losses against other INCOME at the shareholder level. Prior to the 1958 tax-law change, businesses had to choose between being taxed as a CORPORATION (with the benefit of limited LIABILITY but the disadvantage of double taxation; DIVIDENDS paid to owners are not tax-deductible) or as a PARTNERSHIP (with the benefit of single-level, or pass-through, taxation but the disadvantage of unlimited liability). The S corporation rules benefit the small businesses. S corporations are organized as corporations and thus are treated as corporations for legal and business purposes. However, for federal income-tax purposes, they are treated much like partnerships. To become an S corporation, an eligible corporation makes an S election through a filing with the INTERNAL REVENUE SERVICE, which must be signed by all SHAREHOLDERS. The S corporation requirements are somewhat restrictive. The shareholders-related requirements are that the corporation may not have more than 75 shareholders, the shareholders must be individuals/estates/certain TRUSTs/ certain tax-exempt organizations, and none of the individual shareholders can be nonresident aliens. The corporation- related requirements are that the corporation must be a domestic corporation, the corporation must not be an “ineligible” corporation (financial institutions, INSURANCE companies), and the corporation must have only one class of stock. The S election terminates if the corporation fails one or more of the five requirements. Events that can terminate the election include exceeding the 75-shareholder limit, selling an ineligible shareholder one or more share of stock, inadvertently creating a second class of stock (for example distributions not proportionate to ownership percentages), selecting an improper tax year (based on the tax year of the shareholders) or failing the passive INVESTMENT income test for three consecutive years (if a former corporation with earnings and PROFITs). The advantages of S-corporation treatment include the income being exempt from corporate-level taxation (passthrough taxation). Corporate losses can be used at the shareholder level against other income; CAPITAL GAINs, taxexempt income, deductions, losses, and tax credits are separately stated and retain their character when passed through to the shareholder; splitting income among family members is possible (after reasonable compensation is paid to shareholders who provide SERVICES or CAPITAL); and earnings that flow through to individual shareholders as anything other than wages are not subject to the selfemployment tax. Disadvantages of S-corporation treatment include taxation of excessive net passive investment income (if a former C corporation) and built-in gains tax (if a former C corporation). Special allocations and disproportionate distributions are not permitted (as they are in partnerships), and a dividends-received deduction/separate tax-rate schedule is not permitted (as they are in C corporations). In addition, an S corporation is not exempt from the at-risk rules, passive-activity limitations (when investors are not actively involved in management of the business) or the hobby-loss provisions (limitations on deductability of losses associated with a hobby as opposed to business) as are C corporations. Many new small businesses that would have formerly chosen to operate as an S corporation are now electing to operate as a LIMITED LIABILITY COMPANY (LLC) or LIMITED LIABILITY PARTNERSHIP (LLP). As a reaction to this, the Small Business Job Protection Act of 1996 liberalized a number of the S-corporation rules relating to forming, operating, and restructuring S corporations. This was perceived to be an effort by Congress to reinvigorate the S corporation as a viable alternative to the LLC/LLP entity choice. Many small businesses currently operate as an S corporation and will continue to do so into the future. Because there is a significant tax cost involved in corporate liquidation, businesses that might prefer the LLC/LLP form of business will continue their S status. Some small businesses prefer the S-corporation form because the owners perceive it as a possible mechanism of managing the owners’ self-employment tax expense.