What is an S Corporation?

In the realm of business structures and tax elections, the S corporation stands out as a versatile and advantageous option for entrepreneurs seeking the perfect blend of limited liability and favorable tax treatment. The entity, often abbreviated as an “S corp,” combines the liability protection of a corporation with the tax benefits of a partnership or sole proprietorship, making it an attractive choice for small to mid-sized businesses across the United States. This hybrid entity is governed by Subchapter S of the Internal Revenue Code, hence the designation “S corporation.”

The Key Features of an S Corporation:

1. Limited Liability Protection: Like a traditional corporation, an S corporation shields its shareholders from personal liability for business debts and legal obligations. This means that the personal assets of shareholders are generally protected from business liabilities.
2. Pass-Through Taxation: One of the most significant advantages of an S corporation is its pass-through taxation. Unlike C corporations, which face double taxation at the corporate and individual levels, S corporations pass their profits and losses directly to shareholders. This results in a single level of taxation, potentially reducing the overall tax burden for shareholders.
3. Ownership Restrictions: S corps have specific eligibility criteria and ownership restrictions. They can have no more than 100 shareholders, who must be U.S. citizens or residents. S corporations generally cannot be owned by C corporations, other S corps, LLCs, or partnerships.
4. One Class of Stock: S corporations are limited to one class of stock. This ensures equal treatment of shareholders in terms of voting rights and pro-rata distribution of profits.
5. Elimination of the Self-Employment Tax: A common reason that entities elect their business as an S corporation is the elimination of the self-employment tax on business profits. Instead shareholders will pay FICA payroll tax on their reasonable salary which usually ends up being a much lower amount.