An S corporation (S corp) is a U.S. business that elects a special tax status under Subchapter S of the Internal Revenue Code so its profits and losses “pass through” to the owners’ personal tax returns instead of being taxed at the corporate level. It is typically used by small and closely held businesses that want corporate liability protection but partnership-style taxation.
How an S corp works
The S corp itself generally does not pay federal income tax; instead, income, deductions, and credits are allocated to shareholders, who report them on their individual returns and pay tax there. This structure helps avoid “double taxation,” where a regular C corporation pays corporate tax and shareholders then pay tax again on dividends.
Basic requirements
To qualify, the company must be a U.S. (domestic) corporation, have no more than 100 shareholders, only one class of stock, and only eligible shareholders (generally individuals who are U.S. citizens or residents, certain trusts, and estates). Certain types of businesses, such as some financial institutions and insurance companies, are not allowed to elect S status.
Key pros and cons
Advantages include pass-through taxation, potential savings on self-employment taxes when shareholder-employees take a reasonable salary plus distributions, and limited liability for owners’ personal assets. Downsides include ownership restrictions, more formalities and paperwork than an LLC or sole proprietorship, and the need to pay shareholder-employees a “reasonable” salary subject to payroll taxes.
S corp vs. C corp vs. LLC
Feature| S corp| C corp| LLC (default tax)
---|---|---|---
Federal tax level| Pass-through to owners, no entity income tax.27| Pays
corporate tax; shareholders taxed on dividends.35| Usually pass-through to
members.38
Ownership limits| Max 100, U.S. individuals and certain trusts only.15|
Generally unlimited, can include foreign and entity owners.35| Very flexible;
few ownership limits.58
Stock / interests| One class of stock only.16| Multiple classes allowed.57|
Membership interests, very flexible.58
Formalities| Corporate formalities (board, meetings, minutes).57| Same
corporate formalities.57| Generally fewer formalities (varies by state).58
For any decision about electing S corp status, a qualified tax professional or attorney should be consulted because the right choice depends heavily on specific income levels, ownership plans, and state law.
