An S corporation is a corporation (or an LLC that elects corporate treatment) that has filed a valid election under Subchapter S of the Internal Revenue Code to be taxed as a pass-through entity. The company itself generally pays no federal income tax. Instead, profits, losses, and other tax items flow through to shareholders on Schedule K-1 and are taxed on their personal returns. The main appeal for owner-operators is payroll tax savings: an owner who works in the business must take a reasonable W-2 salary, but profits above that salary are distributed free of self-employment tax. Eligibility rules are strict: no more than 100 shareholders, only one class of stock, and shareholders must generally be U.S. individuals, certain trusts, or estates. Partnerships, corporations, and nonresident aliens cannot own S corporation stock.
S Corporation
Primary authority: IRC §§1361-1379 (Subchapter S)
The authority behind it
IRC §§1361-1379 (Subchapter S)
Every entry in this glossary cites the statute, regulation, or IRS guidance behind it.
Worked example
A consultant earning $180,000 of profit as a sole proprietor pays self-employment tax on nearly all of it. As an S corporation paying herself a $90,000 reasonable salary, the remaining $90,000 of profit passes through free of the 15.3% self-employment tax, saving roughly $10,000 to $13,000 per year before payroll costs.
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See what this means on your own income with the free S corp tax calculator.
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Related terms
S Corp Election (Form 2553)
The S corp election is the filing that turns an eligible corporation or LLC into an S corporation for federal tax...
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Reasonable Compensation
Reasonable compensation is the W-2 salary an S corporation must pay a shareholder who works in the business before...
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Shareholder Distributions (S Corporation)
A shareholder distribution is cash or property an S corporation pays to its owners outside of payroll.
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Schedule K-1
Schedule K-1 is the form a pass-through entity issues to each owner reporting that owner's share of the entity's...
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Stock Basis (S Corporation)
Stock basis is a shareholder's running investment account in an S corporation, and it controls three things: how...
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