There are several different types of businesses recognized by the U.S. tax code, including a sole proprietor, partnership, corporation, and Subchapter S corporation. There are advantages and disadvantages to each entity that can affect tax liability. An S corporation, also referred to as S-corp, is a type of corporation that allows shareholders or owners to be considered separate from the business. This provides limited liability, which protects the shareholders to some extent from legal action related to the operation of the S corporation.
In some entity types, the business is subject to tax as well as the shareholders. This is considered double taxation. With an S corporation, profits and losses flow through the business to shareholders. The business itself is not taxed on the federal level, but the shareholders are taxed on their personal returns.
Not all businesses are allowed to consider the S corp option. To be eligible, the business must have only one class of stock, must be considered domestic, and may not have more than 100 shareholders. You can find more specific information on the IRS website, including a listing of industries (such as certain financial institutions) that are ineligible to operate as S-corporations.
Once the business owner determines that an S-corp election can be made, they must register with the IRS as a corporation and then file additional forms to request S-corporation status. Form 2553, “Election by a Small Business Corporation,” and Form 8832, “Entity Classification Election,” are required. State and other local tax agencies may require additional forms to be filed. The IRS will either accept the election or deny it and the business will be notified in writing. If accepted, the S Corporation would file Form 1120S (U.S. Income Tax Return for an S Corporation) annually and the shareholders would report their profits or losses using a Schedule K-1 (Shareholder’s Share of Income, Deductions, Credits, etc.)