Certified Financial Management Specialist Practice Exam

Which of the following is a characteristic of an S Corporation?

1. Double taxation of income

2. Limited liability for owners

3. Single level of taxation

4. Profitability primarily based on shareholder distribution

The correct answer is: Single level of taxation

An S Corporation is designed specifically to avoid double taxation, which is a common issue faced by regular corporations (C Corporations). Instead, an S Corporation allows income, losses, deductions, and credits to be passed through to shareholders, who then report this information on their personal tax returns. This results in a single level of taxation at the individual level, hence it is referred to as "pass-through" taxation. This tax structure is appealing because it helps prevent the corporate income from being taxed at both the corporate level and again at the individual level when profits are distributed as dividends. Thus, the characteristic of single level of taxation perfectly encapsulates one of the key benefits of S Corporations, making it an advantageous choice for many small businesses. In contrast, the other attributes mentioned do not correctly represent the primary characteristics of an S Corporation. For instance, double taxation applies to C Corporations, not S Corporations. While S Corporations do provide limited liability for owners, this characteristic is also shared with other forms of business structures, such as LLCs and C Corporations. Profitability based on shareholder distribution is not a defining characteristic of S Corporations as it could apply to various business structures. Therefore, the choice reflecting the single level of taxation aligns