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What is an S Corporation? | IASourceLink

Posted by Sophie Troxell on Nov 03, 2021

What is an S Corporation?
An S Corporation, or S Subchapter, is another type of legal business entity. What makes an S Corporation stand out from the others? The main difference is that the business elects to pass income, losses, deductions, and credits to their shareholders. This is a major tax advantage as shareholders report these incomes and losses on their personal tax return — allowing the business to avoid double taxation. An S Corporation is usually associated with small businesses, giving them the benefit of being a corporation, without being taxed like one. An S corporation is taxed as a partnership, instead. 

There are certain requirements a business must meet to be eligible for S corporation status. The business must:
  • Have fewer than 100 shareholders
  • Have shareholders who meet the eligibility requirements
  • Have only one class of stock
  • Be incorporated within the U.S.
Advantages of an S Corporation
Since taxes are passed through to shareholders, the money is taxed at their individual tax rates instead of at the corporate tax rate. This allows the business to save money on taxes, lifting a major burden, especially as the business is getting started. S corporation status can also benefit the business owner on his or her personal income taxes. Owners can lower their taxes by categorizing money as salary or dividends — and generate deductions for business expenses and employee wages.

We’ve discussed an individual’s ability to be a shareholder within an S corporation, but what about an employee? Shareholders can double as employees, earning salaries and tax-free corporate dividends. It does come with one stipulation: the dividends cannot be more than the stockholder’s stock basis. If they exceed the stock basis, the excess is taxed as capital gains. Beyond its tax status, an S corporation is very similar to a C corporation.

Disadvantages of an S Corporation
There are guidelines as to who can be a shareholder. Individuals, specific trusts and estates, and certain tax-exempt organizations qualify. Partnerships, corporations, and individuals who are not residents of the United States, are not eligible.

Another disadvantage to choosing the S Corporation designation is that filing as any type of corporation requires more time and resources than filing as an LLC or sole proprietorship. And even though S corporations do have a tax advantage, they still pay taxes on certain built-in gains and passive income at the entity level. 

How to Register
To become an S corporation, you’ll need to fill out Form 2553 Election by a Small Business Corporation. Once all shareholders have signed the form, it can be filed with the IRS. 

For more advice and comparisons on business structures, view our comprehensive guide on how to start a business in Iowa. If questions arise along the way, our team is here to help. The live chat feature in the bottom right corner of the page is a great resource.