What is an S-Corp?

There seems to be a lot of confusion about what an S-corp is. Is it a corporation? Is it a separate business entity? Can any business be an S-corp? How do you become an S-corp? 

What Is An S-Corp?

A subchapter S, or S-corp, is not what you would consider a traditional business entity that’s recognized by states. It is not a type of business but a creation of the internal revenue service (“IRS”) or a tax classification. You don’t incorporate or form an S-corp with a state agency like you do LLC’s or corporations. States don’t care whether or not a business is classified as an S-corp for tax purposes. It's a distinction that is important for filing taxes with the IRS.

Determining whether or not becoming an S-corp is a decision that shouldn’t be taken lightly. There are tax consequences and restrictions that can impact ownership and company structure. 

What Are the Requirements to Become an S-corp?

Not every business can be an S-corp, there are certain requirements that must be met, and paperwork that must be filed with the IRS in order to be classified as an S-corp. Here are the requirements from the IRS that a business must meet in order to qualify for S-corp status:

  • Must be a domestic company - meaning foreign based companies don’t qualify
  • Shareholders or members must be individuals or certain trusts and estates
    • Shareholders or members can’t be partnerships, corporations or non-U.S. resident individuals
  • There can't be more than 100 shareholders or members 
  • There can only be one class of stock or one class of membership 
  • You must be an eligible corporation or LLC - certain financial institutions, insurance companies and domestic international sales companies. 

What Are the Advantages of Being an S-Corp?

  • You still get the limited personal liability for shareholders or members. Provided you don’t personally guarantee any obligations, you aren’t going to be on the hook for the business debts and liabilities. This means that creditors aren’t going to be able to come after your personal assets (think house, bank accounts, etc.) if something goes wrong with the business or the company doesn’t pay its debts. 
  • You can still take advantage of pass through taxation. S-corps don’t pay federal taxes at the corporate level (and many states follow this rule as well). So, any business income or loss is “passed through” to the owners and reported on their individual tax returns. This would allow for a business loss to offset other income on an owners tax return, which may be beneficial to owners during the start up phase of the business. 
  • S-corp owners can be employees of the company and draw a salary like typical employees of a business do. They can also receive dividends/draws from the company and other distributions that may be tax free if they are classified as drawdowns on a capital account. This can allow owners to reduce the self-employment tax they pay. 

What Are the Disadvantages of an S-Corp?

  • As mentioned above, there are certain requirements that must be met in order to become an S-corp, one of which puts some restrictions on ownership. Depending on how you’re planning to structure your company and who the owners might be, a potential disadvantage is that you don’t qualify for the S-corp status based on the specific makeup of your business. 
  • There may be less flexibility in accounting for profits and losses. You’re only allowed one class of stock or membership interest in an S-corp, which places some limitations on how you can allocate losses and profits to specific owners. The profits and losses will have to be allocated to the owners based on the percentage of the company they own. 
  • As an S-corp, the company and owners should make sure all compliance requirements are followed. Your bylaws or operating agreement may dictate how that decision has to be made, documented and filed, so make sure all of that is done correctly and that profits and losses are distributed correctly. If these “formalities” aren’t followed, the IRS could terminate the S-corp status. This could lead to some increased administrative burden and costs that may not be associated with some other business entities.  

Determining what business entity is right for your business is an important step and shouldn’t be taken lightly. S-corps can be a great fit for many companies and it’s certainly an option that should be on the table if the requirements are met. Remember to make sure to cover all your bases as you're looking into the best business entity - legal, tax, regulatory, etc. There are a lot of factors that come into play with business entities so make sure to seek the necessary information for your individual circumstances. 


If you have any questions about S-corps, business entities or legal and business advisory services in general, contact usfor a free consultation. 




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