An S Corporation is a special type of corporation in the United States that elects to pass corporate income, losses, deductions, and credits directly to shareholders for federal tax purposes. This structure allows income to be taxed only at the shareholder level, avoiding double taxation on corporate profits. To qualify for S Corporation status, a business must meet specific IRS requirements, including having no more than 100 shareholders, all of whom must be U.S. citizens or residents, and issuing only one class of stock.
S Corporations are popular among small to mid-sized businesses because they combine the legal protections of a corporation with the tax advantages of a partnership. However, they must adhere to strict operational and reporting guidelines, and profits are distributed based on ownership percentage, regardless of whether distributions are actually made.
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Key Facts
- Pass-Through Taxation: Income is reported on shareholders’ personal tax returns, not taxed at the corporate level.
- Ownership Restrictions: Limited to 100 shareholders, all must be U.S. citizens or residents, and shareholders must be individuals, certain trusts, or estates.
- Formal Election Required: Must file IRS Form 2553 to elect S corporation status.
- Liability Protection: Provides shareholders with limited liability protection, similar to a C corporation.
- Eligibility Limits: Cannot have multiple classes of stock and certain businesses are ineligible (for example, some financial institutions).
1. How does an S corporation differ from a C corporation?
S corporations avoid double taxation by passing income to shareholders, while C corporations are taxed at both corporate and shareholder levels.
2. Who can be shareholders in an S corporation?
Only U.S. citizens or residents who are individuals, certain trusts, or estates; no corporations or partnerships allowed.
3. What are the tax benefits of an S corporation?
Avoids double taxation, allows profits and losses to flow through to individual tax returns, which may reduce overall tax liability.
4. How do you form an S corporation?
First, form a regular corporation at the state level, then file IRS Form 2553 to elect S status.
5. Can an S corporation have employees?
Yes, S corporations can hire employees and must pay reasonable salaries to shareholder-employees.
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