An S corporation is a specific type of corporation under federal tax law. Its profits and losses are allocated to its owners for tax purposes, rather than the corporation being taxed separately. It's designed as a useful corporate structure for small businesses. Individuals can be shareholders in S corporations, but each S corporation is only allowed to have 100 shareholders or fewer.
Individuals are legally allowed to invest in an S-corp as they see fit. However, S-corporations can legally only have 100 or fewer shareholders.
S Corporation Basics
An S corporation is usually incorporated like other corporations under state law and, for federal tax purposes, chooses to be treated as an S corporation. That means that its profits or losses pass through to its owners, who pay and file taxes accordingly, rather than the corporation being taxed as a separate entity. To elect to be an S corporation, each shareholder must sign Internal Revenue Service Form 2553.
Corporations that are separately taxed are generally known as C corporations. The one-letter names come from two sections of the Internal Revenue Code that define the corporation types. Some small businesses also incorporate as limited liability companies under their state laws, and an LLC can often choose to be taxed as either an S corporation or a C corporation.
Though an S corporation doesn't pay federal income tax directly, it still generally must file Form 1120S, an income tax return specifically for S corporations. Its shareholders must then report their share of profits or losses on their own personal tax returns, generally using an IRS form called Schedule E. The corporation also must file and pay Social Security and Medicare tax for its employees if it has any, as well as other relevant state, local or federal tax forms.
Most states follow the federal government's lead in taxing S corporation shareholders, rather than the corporation itself, though a few states tax S corporations much like other corporations. This avoids so-called double taxation on the company's earnings, since they're not taxed once as income to the corporation itself and separately as income to the shareholders.
An S corporation is generally limited to having at most 100 shareholders and they must be individuals or certain kinds of trusts or estates. Relatives and spouses can often be treated as single shareholders. Another corporation can't buy in to an S corporation, nor can a partnership.
S corporations are required to only have one class of stock, unlike C corporations which can have preferred stock or other special types with different dividend and voting rules. Profits and losses are required to be passed through to owners according to share ownership percentages.
- U.S. Small Business Administration: S Corporation
- Entrepreneur: Business Structure Basics
- Nolo: S Corporation Facts
- IRS: S Corporations
- IRS: Form 2553
- IRS: Instructions for Form 1120S
- PREVALENT | definition in the Cambridge English Dictionary
- BizFilings: Compare S Corporation vs C Corporation
- IRS: Schedule E
- Nolo: Why You Might Choose S Corp Taxation for Your LLC
Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.