S Corporation FAQs

What is an S corporation?

corporation faqStandard business corporations or C corporations are required to pay income tax on taxable income generated by the corporation. By completing and filing federal Form 2553 with the IRS, your C-corporation will elect sub chapter S election. This is a way to avoid having your corporation treated as a separately taxed entity.

An S corporation is a standard business corporation that has elected a special tax status with the IRS. This tax treatment allows the corporation not to be a taxed separately. Instead, the income of the corporation is treated like the income of a partnership or sole proprietorship in that the profits or losses of the company “flow through” or are “passed-through” to the shareholders. Therefore, the shareholders’ individual tax returns report the income or loss generated.

Most small business owners naturally will avoid double taxation by paying out income in the form of salary and bonuses. Both salary and bonuses, and any other form of employee compensation, are direct reductions from the net income of the corporation, hence taxing the owner only once, at the individual level.

In order to qualify for S corporation status, the corporation can have no more than 75 shareholders, who must all consent in writing to the election to be an S corporation. The shareholders cannot be non-resident aliens. Also, an S corporation can have only one class of stock (Common Stock).

What are the advantages of an S corporation?

  • S corporations avoid the possibility of double taxation on profits
  • Shareholders of an S corporation are typically not personally responsible for the debts and liabilities of the business
  • Ownership of an S corporation is easily transferable through the sale of stock
  • S corporations have unlimited life extending beyond the illness or death of the owners
  • Additional capital can be raised by selling shares of the S corporation’s stock
  • Potential customers may perceive an S corporation as a more professional entity than a sole proprietorship or partnership
  • S corporations are generally audited less frequently than sole proprietorships
  • Certain S corporation business expenses may be tax-deductible
  • S corporations can result in Self-Employment Tax Savings
  • S corporations may provide a number of income and tax savings

What are the disadvantages of an S corp?

S corporations are subject to restrictions imposed by the IRS on who can be owners.
Owners (shareholders) must meet the following criteria:

  • Number fewer than 100
  • Cannot be non-resident aliens
  • Cannot be C corporations, other S corporations, limited liability companies (LLCs), partnerships or certain trusts.

Other disadvantages:

  • There is more complexity and expense with forming a corporation.
  • There is more extensive record keeping requirements.
  • Operating a corporation across state lines often requires the corporation to qualify to do business in the other state.