S-Corporation FAQs Back to All FAQs

What is an S corporation?

An S Corporation, also known as an S Corp, is a specific tax designation in the United States that allows certain corporations to avoid double taxation on corporate income. The term "S Corporation" refers to Subchapter S of the Internal Revenue Code, under which qualifying corporations can elect to be taxed as pass-through entities. This means that the corporation itself does not pay federal income taxes; instead, income, deductions, and credits flow through to the individual shareholders' tax returns.

Here are key characteristics of S Corporations:

1. Pass-Through Taxation: One of the main benefits of an S Corporation is pass-through taxation. The corporation's income, deductions, and credits are passed through to the individual shareholders, who report these items on their personal income tax returns. This avoids the double taxation typically associated with traditional C Corporations, where the corporation pays taxes on its profits, and shareholders pay taxes on dividends.

2. Limited Liability: Like C Corporations, S Corporations provide limited liability protection for shareholders. This means that the personal assets of the shareholders are generally protected from the debts and liabilities of the corporation.

3. Restrictions on Ownership: S Corporations are subject to certain restrictions on ownership. They cannot have more than 100 shareholders, and shareholders must be U.S. citizens, resident aliens, certain trusts, or tax-exempt organizations. Additionally, only individuals, certain trusts, and estates can be shareholders.

4. Single Class of Stock: S Corporations can have only one class of stock, meaning that all shareholders have the same rights in terms of dividends and liquidation proceeds. This restriction helps maintain simplicity in the corporate structure.

5. Formation Requirements: To elect S Corporation status, a corporation must meet specific eligibility criteria and file Form 2553 with the Internal Revenue Service (IRS). Eligibility requirements include being a domestic corporation, having only allowable shareholders, and having a valid tax year.

6. Fiscal Year Elections: S Corporations generally follow a calendar year for tax purposes. However, under certain circumstances, they may be eligible to adopt a fiscal year.

7. Distributions and Salary: Shareholders of S Corporations often receive income in the form of both salary and distributions. Shareholders who are also employees must receive reasonable compensation, subject to employment taxes, for the services they provide to the corporation.

It's important to note that while S Corporations offer advantages, they may not be suitable for every business. Factors such as the number and type of shareholders, the desire for pass-through taxation, and the business's growth plans should be carefully considered. Consulting with a tax professional or legal advisor is advisable when determining the most appropriate business structure based on the specific needs and circumstances of the business and its owners.

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