What Is An S Corporation?
An S corporation is a corporation that avoids paying taxes by pushing its income, losses, deductions, and credits to its shareholders.
The term “S corporation” means a “small business corporation.” It is a type of legal business entity that does not pay income taxes. Instead, it passes its losses, deductions, and credits to its shareholders, who must report everything on their income tax returns.
By dividing its income and losses among its shareholders, S corporations avoid double taxation. Double taxation is a situation where income is taxed twice – at the corporate level and personal level. Double taxation occurs because corporations are separate legal entities from their shareholders in the eye of the law.
To qualify for the status and enjoy the tax exemption privilege, the shareholders must sign and submit a “Form 2553 Election by a Small Business Corporation.” The corporation must also meet the following conditions:
- Incorporated domestically (i.e. in the United States)
- No more than 100 shareholders.
- Has only one class of stock.
- Is not an insurance company, bank, or ineligible corporation, as specified by the Internal Revenue Service (IRS).
Profits and losses are allocated to their shareholders based on the percentage of ownership or amount of shares each holds. The shareholders then pay taxes on their proportional shares of the received profits.
The main benefit by identifying as an S corporation is the exemption from paying income tax. Aside from not paying income taxes, it is no different from other corporations.
S Corporation Example
Sam owns a small bakery in town with 25 shareholders. His lawyer advises him to register the bakery as an S corporation to save money on their taxes. Sam gets his shareholders to agree, and they file Form 2553 required by the IRS. Due to the company’s status as an S corporation, the bakery no longer pays; instead, the shareholders pay taxes based on their share.« Back to Glossary Index