S Corporation (S-Corp): Benefits, Requirements & How to File

According to the United States Department of Commerce, S corporations make up 76.8% of corporations with fewer than 500 employees. While there are many tax advantages to this business structure, it also carries specific requirements. Before creating an S corporation, it’s essential to understand its definition, benefits, eligibility rules, and filing process.

What Is an S Corporation?

An S corporation is a tax election that allows a limited liability company (LLC) or a qualifying corporation to pass through income, losses, and deductions directly to shareholders’ returns. This allows the S corporation to avoid federal corporate taxes.

In 1958, Congress passed the Technical Amendments Act, creating S corporations to help small businesses avoid double taxation. Before this tax election, business owners had to choose between a partnership’s loss of control and a C corporation’s double taxation. The new election was called an S corporation election under Subchapter S of the Internal Revenue Code (IRC).

S Corp as a Tax Election, Not a Business Structure

An S corporation structure isn’t like a normal business structure, so you can’t form an S corporation directly. Instead, you need to first create an LLC or a C corporation. Afterward, you can elect S corporation tax treatment by filing Form 2553 with the IRS.

The actual entity doesn’t change. You still have the same LLC or corporation, but you are taxed differently. This is an important factor to remember because your liability protection stems from your entity structure and not your tax status.

How S Corp Taxation Works

Unlike C corporations, S corporations do not have to pay federal income tax. All of your profits or losses are passed through to shareholders using a Schedule K-1. Then, the shareholders are responsible for reporting their shares on their personal tax return.

S corp owners save money through reduced payroll taxes and the absence of corporate-level income taxes. Owner-employees must be paid a reasonable salary. Any remaining profits are distributed to owners and therefore aren’t subject to employment taxes. Payroll taxes are only paid on the actual salary.

For a simplified example, let’s assume a business earns $180,000 in profit per year. The owner is paid a reasonable salary of $70,000. The $70,000 is subject to payroll taxes, but the $110,000 is not. As the employer and employee, the S corp owner would normally have to pay a total of 15.3% in payroll taxes on their wages. By switching from a sole proprietorship to an S corporation, they can save roughly $16,000.

Key Benefits of an S Corporation

Learning how to form an S corporation offers several important benefits over other business structures. However, there are also trade-offs that owners must be aware of.

Avoids Double Taxation

C corporations pay a 21% corporate income tax rate. If dividends are paid, shareholders are also taxed on the dividends. In comparison, S corporations are only taxed once at the shareholder level. This straightforward tax treatment is the primary reason small business owners elect S corporation status.

It’s also important to note that profits will be taxed whether or not the cash is distributed. Even if the profits are left in your business account, it still passes through to your personal income tax return.

Reduces Self-Employment Tax

For S corporation owner-employees, one of the most important benefits is paying less in self-employment tax. You are required to pay yourself a reasonable salary, which varies based on your skills, career field, location, and other factors. This salary is subject to the 15.3% combined Social Security and Medicare taxes.

Any profit past this amount can be taken as a distribution. With a distribution, you don’t have to pay any payroll taxes. As our earlier example showed, someone who earns $180,000 in profit and a reasonable salary of $70,000 can save roughly $16,000 in self-employment taxes. 

QBI Deduction Eligibility (2025)

S corp owners can also save money at tax time with a Section 199A Qualified Business Income (QBI) deduction. The QBI deduction can be used for up to 20% of qualified business income. However, it has a taxable income threshold of $201,750 for single filers and $403,500 for married couples filing jointly. At this point, the deduction starts to phase out. 

This deduction is specifically available to sole proprietorships, partnerships, and S corporations. C corp shareholders cannot take advantage of the QBI deduction.

Limited Liability Protection

The S corp election doesn’t protect you from liability, but the underlying C corp or LLC structure does. You have to form a C corp or LLC to become an S corp, which is why people often get confused about whether an S corp provides liability protection. Thanks to these underlying structures, you are not personally liable for your business's legal judgments or debts.

Perpetual Existence

When the sole proprietor dies, the sole proprietorship dissolves. With an S corporation, the corporation continues to exist if the owner retires or passes away. Ownership is transferred through stock (or membership interests in LLCs) to an eligible shareholder, making succession planning especially important.

S Corporation Eligibility Requirements

You must meet certain qualifications to set up and maintain your S corporation. If you do not meet these requirements or violate them in the future, your S corporation election will be automatically terminated.

Must Be a Domestic Corporation or LLC

One of the main requirements for an S corporation is that it must be incorporated and organized in the United States. Foreign corporations are not eligible.

Maximum of 100 Shareholders

Unlike C corps, S corps have strict shareholder limitations. S corporations are not allowed to have more than 100 shareholders. However, family aggregation rules allow family members to be counted as a single shareholder in certain situations.

Only Eligible Shareholders Allowed

All shareholders must be United States citizens, residents, qualifying trusts, or estates. S corporations cannot have foreign shareholders. Additionally, S corporation stock cannot be held by partnerships or other corporations. Even if there is only a single ineligible shareholder, it can void your entire S corporation election.

Only One Class of Stock

S corporations cannot have preferred stock. All shares must have identical rights to distributions. If the company is dissolved, shares must also have equal rights during liquidation. This type of corporation is not a good option if you want to attract venture capital funding. You also cannot go public through an initial public offering (IPO) as an S corporation unless you first convert to a C corporation.

Cannot be an Ineligible Corporation

There are also specific restrictions on which types of businesses can become S corps. For example, insurance companies, certain financial institutions, and domestic international sales corporations are among the organizations that are ineligible for an S corporation election. Regulated industries may face restrictions, so check before electing S corp status.

Disadvantages of S Corp Status

Having S corp status offers several important benefits, but it isn’t right for everyone. Consider the following drawbacks before you set up an S corporation for your business.

Reasonable Salary Requirement

Owner-employees must pay a reasonable salary. If the salary is too low for your role or industry, it can trigger an audit. Unfortunately, there is no fixed formula for reasonable compensation. Instead, the IRS compares your earnings to what a non-owner employee would earn for the same work. Having to set a reasonable salary and handle payroll adds an extra level of compliance costs and complexity.

Ownership Restrictions Limit Funding

The cap on the number and type of shareholders makes it challenging to raise institutional venture capital. If you plan on seeking outside investment, you will likely need to incorporate as a C corp instead.

Increased Administrative Complexity

S corporations are more administratively complex than a basic LLC. You’ll need to set up payroll processing, conduct annual shareholder meetings, keep board minutes, and maintain separate corporate records. Most likely, you’ll need an accountant, a bookkeeper, and payroll software. If you’re concerned about overhead as you’re starting, managing an S Corp can be cost-prohibitive.

IRS Scrutiny

S corporations can save owners significant tax savings, which is why the IRS closely monitors them. In particular, they look closely at how you structure your salary. If you’re bringing in $500,000 in profits and earning only a $36,000 salary, that is a red flag. To avoid this problem, you need to document that reasonable compensation was paid.

S Corp vs. C Corp: Quick Overview

While S corps and C corps are popular business structures, they differ in taxation, ownership limitations, investor suitability, and stock classes.

Interested in seeing a full side-by-side breakdown? Check out our C corp vs. S corp guide.

S Corp vs. LLC: What Is the Difference?

The biggest difference between an S corporation and an LLC is that an LLC is a legal entity, whereas an S corporation is a tax election. An LLC can be taxed as an S corporation, a sole proprietorship, or a partnership, depending on whether the LLC owner elects S corporation status. If you set up an LLC without an S corporation election, you’ll automatically be taxed as a partnership or sole proprietorship by default.

Often, people decide to elect S corporation status for two key reasons.

• Tax Savings: As a general rule of thumb, self-employment tax savings start to happen once your company’s profits are at about $80,000. 
• QBI Deductions: The QBI deduction can reduce taxable business income by up to 20%.

If you are an LLC without an S corporation election, you will be taxed as a partnership or sole proprietorship by default. The decision to elect S corporation status should be based on your profit level and the administrative complexity you can handle. 

How To File for S Corporation Status: Step by Step

What is an S corporation election? And how do you file for S corp status? After understanding how an S corporation election works, the next steps are to form your entity and file the election.

Step 1: Form Your LLC or Corporation

You must have an underlying legal entity to elect S corporation status. To make an LLC, you must file Articles of Organization with your state's Secretary of State. For a C corporation, you’d need to file Articles of Incorporation instead. You also must pick a business name, appoint a registered agent, and pay your state’s filing fee.

To see if your chosen business name is available in your state or other states, you can use EntityCheck’s Secretary of State (SOS) Business Search.

Step 2: Get Your Employer Identification Number (EIN)

You’ll need to go to the IRS website to apply for an EIN. The process is completely free and takes about 15 minutes. Afterward, you can use the EIN when you fill out Form 2553, complete your state tax registration, or set up a bank account. If you are unsure if you already have a registered EIN, you can use EntityCheck’s Instant EIN Search. 

Step 3: Confirm IRS Eligibility

Ensure your business meets the IRS requirements to qualify as an S corporation.

• Domestic entity
• Maximum of 100 shareholders
• One class of stock
• Eligible shareholders only
• Eligible corporation or entity type

Failing to meet even one requirement can cause your S corporation election to be automatically terminated.

Step 4: File IRS Form 2553

Form 2553 must be completed and signed by every shareholder. It should be completed within 75 days of entity formation or before March 15 of the tax year you want the election to take effect. You can still become an S corporation if you miss the deadline, but you’ll have to wait until the next tax year for the election to apply. 

LLCs may also need to file Form 8832. This allows you to be treated as a corporation.

Step 5: File Your State S Corp Election (If Required)

While most states automatically recognize your federal S corporation election, this isn’t true everywhere. For example, California and New York have different state-level requirements for electing S corporation status. California also charges a 1.5% entity-level franchise tax on S corp net income. Your state may also charge specific franchise taxes, so research your state’s requirements before completing your election.

Step 6: Set Up Payroll for Owner-Employees

Once your S corp election is set up, you’ll need to process payroll and pay your owner-employees a reasonable salary. You must also file annual W-2s and quarterly payroll tax returns through Form 941, which can increase the complexity and cost of operating an S corporation.

Maintaining S Corporation Status: Ongoing Compliance

Once you meet your initial S corporation qualifications, there are additional steps to maintain your election status. If any eligibility rule is violated, you can automatically lose your S corporation status.

Annual Tax Filing (Form 1120-S)

Each year, you must file Form 1120-S before March 15 if you are a calendar-year business. A Schedule K-1 must be completed for each shareholder so they can file their personal tax returns. If you must file 10 or more returns per year, you must e-file everything.

Quarterly Payroll Tax Filings

Each quarter, you must use Form 941 to report and pay Social Security, Medicare, and income taxes. If you miss a filing, it can trigger extra IRS scrutiny.

Corporate Formalities

Maintaining your corporate formalities helps to lower the likelihood of an audit. It also strengthens your liability protections by reducing the risk of a piercing of the corporate veil. As part of these formalities, you should hold annual meetings, document your major business decisions, and record your board minutes. Additionally, you should always keep your business and personal accounts separate.

What Happens If S Corp Status Is Revoked?

If any eligibility rule is violated, the S corporation election is revoked. This occurs retroactively to the date of the violation, so you could end up paying a significant amount in back corporate taxes if your S corp defaults to C corp tax treatment.

Unfortunately, you can’t simply fix the problem and return to S corp status again. Instead, you will be unable to re-elect S corporation status for five years unless the IRS grants a special waiver.