The Internal Revenue Service allows a corporation to elect to be treated as a small business corporation, or S corporation, for federal income tax purposes, provided the corporation complies with certain requirements. The S corporation election enables the company to avoid being taxed at regular corporate rates under most circumstances. There is an exception that applies when passive income exceeds 25 percent of gross receipts. This rule makes it particularly important for shareholders of an S corporation to understand which sources of revenue should be included in the computation of the company's gross receipts.
An S corporation's gross receipts are its total revenue received from all income sources during an annual accounting period. This amount is not reduced by any costs or expenses. The definition of gross receipts is typically established by the entity using the term, and can differ a bit in certain circumstances, such as when used by a state taxing authority versus the IRS. In most instances, gross receipts do not include withholding taxes or proceeds from the sale of fixed assets.
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