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What is an S Corporation?

S-corporations (S-corps) are tax designations for corporations and limited liability companies (LLCs). They are limited to 100 shareholders.

Business entities taxed as S-corps do not pay a corporate income tax. Instead, the business's gains pass through to the owners, who must report those gains as income on their personal tax returns.

Aside from a few designated taxes for built-in gains and passive income, the gains and losses of a company are assessed at shareholders' personal income tax rates. Therefore, S-corps avoid the double taxation found in C-corporations (C-corps).

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Key Takeaways

  • An S-corp is not a business structure; it is a tax designation available to corporations and LLCs.
  • S-corps are like C-corps, except for the way they pay federal income taxes and limits on who can own shares.
  • S-corps avoid taxation at the corporate level, but shareholders are taxed on any profits in their individual tax returns.
  • Companies can obtain an S-corps designation if all shareholders sign and submit an IRS Form 2553.

Understanding S-Corporations

The Internal Revenue Service (IRS) says business entities must meet the following requirements to qualify for S-corp status:

  • They must be a domestic corporation
  • Have allowable shareholders (individuals, certain trusts, and estates)
  • Have no more than 100 shareholders
  • Have only one class of stock
  • Not be an "ineligible" corporation, such as an insurance company

S-corps refer to businesses taxed under Subchapter S of the U.S. Internal Revenue Code. As stated above, they are limited to 100 shareholders. Because they are not subject to double taxation like C-corps, S-corps pay very little in corporate taxes. Instead, the gains or losses of S-corps pass through to the shareholders, who must then report them on their individual tax returns.

Apart from these critical differences, S-corps share a lot in common with C-corps. They are both for-profit companies governed by state and federal law.

S-corps are also required to follow many of the same formalities as C-corps, such as having a board of directors, bylaws, shareholder meetings, and record-keeping of company meetings.

Organizing as an S-Corporation

C-corp, not S-corp, is the default tax entity for all incorporated companies. To change an LLC or corporation's tax status to an S-Corp, shareholders must sign and submit an IRS Form 2335.

The IRS provides helpful instructions for how and where to file the form.

Answering Your Legal Questions

Most business owners have questions as they prepare forms like IRS Form 2553. When you're unsure about your next steps, it's always best to contact a small business lawyer who can guide you.

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