What is an S Corporation?

Corporations offer limited liability protection for their shareholders. If the business is sued or is in debt, the shareholders’ personal assets are not at risk. However, a significant drawback is double-taxation where profits are taxed at the corporate level and then again once the owners receive distributions. A company may choose to change their default status of a C corp to an S corp.

Business entities taxed as an S-corp 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. This pass-through taxation is similar to sole proprietorships and partnerships.

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).

Form your corporation with confidence with our trusted partner LegalZoom.

Key Takeaways

• An S-corp is not a business structure; it is a tax election available to corporations and LLCs.

• S corporations are limited to 100 shareholders or members.

• S-corps avoid taxation at the corporate level, but owners are taxed on any profits on their individual income tax returns.

• Companies can obtain an S-corp 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 eligibility 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. They are not subject to double taxation like C-corps. 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. They provide limited liability protection to the owners so their personal assets are not at risk.

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-corporation status is the default tax status 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 2553, Election by a Small Business Corporation.

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

Can an LLC Elect S Corporation Status?

Yes. The LLC may opt to be taxed as an S Corporation. A limited liability company (LLC) is a default pass-through entity, where the profits and losses go on the member’s individual tax returns. The LLC offers pass-through taxation and limited liability protection for its members, making it a popular corporate structure for entrepreneurs.

However, LLC members must pay self-employment taxes. They may choose to become an S corp to allow the owners to pay themselves a salary and take the remaining profits as distributions, thereby reducing their payroll tax liability.

Answering Your Legal Questions

Most business owners have questions about the tax advantages of S corporations and when preparing 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.

Related Terms

• Corporations
• LLCs
• Tax Differences Between C and S-Corporations