Chauncey grew up on a farm in rural northern California. At 18 he ran away and saw the world with a backpack and a credit card, discovering that the true value of any point or mile is the experience it facilitates. He remains most at home on a tracto.
Chauncey Crail ContributorChauncey grew up on a farm in rural northern California. At 18 he ran away and saw the world with a backpack and a credit card, discovering that the true value of any point or mile is the experience it facilitates. He remains most at home on a tracto.
Written By Chauncey Crail ContributorChauncey grew up on a farm in rural northern California. At 18 he ran away and saw the world with a backpack and a credit card, discovering that the true value of any point or mile is the experience it facilitates. He remains most at home on a tracto.
Chauncey Crail ContributorChauncey grew up on a farm in rural northern California. At 18 he ran away and saw the world with a backpack and a credit card, discovering that the true value of any point or mile is the experience it facilitates. He remains most at home on a tracto.
Contributor Jane Haskins, J.D. contributorJane Haskins practiced law for 20 years, representing small businesses in startup, dissolution, business transactions and litigation. She has written hundreds of articles on legal, intellectual property and tax issues affecting small businesses.
Jane Haskins, J.D. contributorJane Haskins practiced law for 20 years, representing small businesses in startup, dissolution, business transactions and litigation. She has written hundreds of articles on legal, intellectual property and tax issues affecting small businesses.
Jane Haskins, J.D. contributorJane Haskins practiced law for 20 years, representing small businesses in startup, dissolution, business transactions and litigation. She has written hundreds of articles on legal, intellectual property and tax issues affecting small businesses.
Jane Haskins, J.D. contributorJane Haskins practiced law for 20 years, representing small businesses in startup, dissolution, business transactions and litigation. She has written hundreds of articles on legal, intellectual property and tax issues affecting small businesses.
Updated: Jul 26, 2024, 7:46pm
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An S-corp is a type of corporation that elects to pass corporate income, loss, deductions and credits to its shareholders. In other words, an S-corp is a tax status classification that some businesses can elect. It provides limited liability while enabling corporations that have less than 100 shareholders to be taxed as a partnership. However, it’s important to know the advantages and limitations of an S-corp before jumping at the pass-through tax advantages it offers.
This guide covers everything you need to know about the requirements for electing S-corp status, including details of its strict requirements on shareholders and stock so you can decide if it’s the right choice for your company.
An S-corp is a specific tax designation governed by the tax code’s subchapter “S”—where it gets its name. An LLC or a corporation may elect “S” status if it meets the requirements laid out in the subchapter, the majority of which deal with limits on shareholders and stock. The defining feature of an S-corp is its “pass-through” tax structure. An S-corp doesn’t pay corporate income tax. Instead, corporate income, losses, deductions and credits pass through to shareholders for federal tax purposes.
Because an S-corp is not a business structure, businesses must first be created as either a corporation (normally taxed as “C-corps”) or LLCs (limited liability companies, normally taxed as sole proprietorships or partnerships). Either type of business can choose to be taxed as an S-corp, but the typical reasons for choosing S-corp status vary.
LLCs often choose S-corp status to reduce the owners’ self-employment taxes. By default, LLC owners are self-employed, paying both personal income tax and self-employment tax on their share of business profits. If the LLC elects S-corp status, the owners can be company employees, paying employment taxes on their reasonable salary but not on the business’s total profits.
Corporations typically elect S-corp status to avoid double taxation of distributions. Traditional C-corporations pay corporate income tax on their profits. When those profits are distributed to shareholders, the shareholders also pay personal taxes on them. With an S-corp, there is no tax at the corporate level, so profits are only taxed once, at the shareholder level.
For more specifics, check out our guide on S-corps or our other articles on the advantages and disadvantages between LLCs and S-corps and the differences between C-corp and S-corp elections.
Not every LLC or corporation qualifies for S-corp taxation. The IRS has strict requirements for S-corp status, and it’s generally limited to smaller, domestically owned companies. The requirements can be broken down into a few simple categories: requirements for the type of corporation you will be operating, requirements for the shareholders who will own stock in your company and requirements for correctly filing your S-corporation with both your state and the IRS.
Your S-corporation election requires your entity must be a domestic business, meaning it must have been formed or incorporated within the United States. Your S-corporation must also not be an ineligible corporation. The IRS defines ineligible corporations as “certain financial institutions, insurance companies and domestic international sales corporations.” If you’re running one of these types of businesses, consult with tax and legal professionals before attempting to make an S-corp election.
Finally, your corporation can only have one class of stock, disregarding differences in voting rights. The IRS treats stock as being in one class if all shares have equal rights to distribution and liquidation proceeds. Because LLCs do not issue stock, it’s best to consult with a lawyer or accountant to find out how this requirement applies to your business.
Your S-corporation must also fit strict requirements for the shareholders (or members, in the case of an LLC) who own your business. Most importantly, you must have no more than 100 shareholders to qualify as an S-corporation.
You must also only have what the IRS defines as “eligible shareholders,” meaning shareholders must be individuals, certain trusts or estates. Shareholders also must be U.S. citizens or legal residents. Partnerships and corporations cannot be shareholders.
