What is an S Corporation? Tax benefits explained

Published Friday 16 January 2026

Table of contents

• What is an S corporation?
• S corporation requirements and restrictions
• Benefits of choosing an S corporation
• S corp considerations and limitations
• S corp vs LLC
• S corp vs C corp
• How to form an S corporation
• Managing your S corp with the right tools
• FAQs on S corporations

Key takeaways

• Recognize that S corporations provide personal asset protection from business liabilities while offering pass-through taxation that avoids double taxation, making them ideal for businesses seeking both legal protection and tax efficiency.
• Ensure your business meets strict IRS requirements before electing S corp status, including having no more than 100 US citizen or permanent resident shareholders and issuing only one class of stock.
• Implement proper payroll processes for owner-employees who must receive reasonable salaries subject to payroll taxes, while remaining business profits distributed to owners avoid self-employment tax.
• Prepare for increased administrative responsibilities and costs, including filing articles of incorporation, maintaining corporate bylaws, conducting board meetings, and potentially hiring professional help for compliance requirements.

What is an S corporation?

An S corporation (S corp) is a business structure that combines corporate liability protection with pass-through tax treatment. This means owners get personal asset protection while avoiding double taxation on business profits.

S corporations must meet specific Internal Revenue Service (IRS) requirements to maintain this tax status.

OK, so what's a corporation?

A corporation is a legal business entity separate from its owners. All corporations share three key roles:

• Shareholders: Own the business
• Officers: Oversee day-to-day operations of the business (think chief executive officer, chief financial officer, and chief operations officer)
• Directors: Represent the voice of shareholders to the officers and help set strategy and policy for the business

A single person can be a shareholder, officer and director. In smaller corporations, it's common for a handful of people to hold all three roles.

In this setup, shareholders own the corporation and the corporation, in turn, owns the business. This arrangement creates significant legal separation between the owners and the business.

If the business owners work at the business, they are paid wages and receive a W-2 tax form just like any other employee.

S corporation requirements and restrictions

To qualify for S corporation (S corp) status, your business must meet specific Internal Revenue Service (IRS) requirements. These rules cover who can be an owner and how the company is structured.

S corporation eligibility requirements:

• Maximum shareholders: 100 shareholders at any time
• Citizenship requirement: All shareholders must be US citizens or permanent residents
• Ownership restrictions: No corporate shareholders (except certain trusts and estates)
• Stock classes: Only one class of stock allowed

Benefits of choosing an S corporation

Personal asset protection

Personal asset protection shields your personal wealth from business liabilities. If your S corp faces lawsuits or debts, creditors can only claim business assets.

Important exceptions apply: You remain personally liable for negligent acts and any debts you personally guarantee.

Tax treatment

S corporation tax treatment eliminates double taxation through pass-through taxation. Business profits flow directly to owners' personal tax returns.

Key tax advantages:

• Vs C corporations: Avoids double taxation (corporate tax plus dividend tax)
• Compared with sole proprietorships: reduces self-employment taxes on business profits
• Working owners: Must take a reasonable salary subject to payroll taxes, but remaining profits avoid self-employment tax. It's crucial to get this right, as the U.S. Government Accountability Office found that compensation underreporting equaled roughly $23.6 billion over two years, leading to significant tax underpayments.

Extra discipline

Adopting clear corporate structures and processes can help you make more strategic decisions. The discipline of defined responsibilities, board meetings and reporting can help a business mature.

S corp considerations and limitations

Extra admin

Forming an S corporation requires several legal documents and ongoing compliance, so you need clear processes and support to manage it well. In fact, a government report found that 68% of S corp returns misreported at least one item.

• Formation documents: Articles of incorporation and corporate bylaws
• Ongoing requirements: Annual reports and documented board meetings
• Professional help: Legal assistance typically needed for proper setup

Added costs

You'll need to pay fees when filing to become an S corporation and there may be modest ongoing costs depending on what state you're in. Then there are the indirect costs of forming and running a corporation, such as getting legal support for the filing process and preparing annual reports (required in some states).

You also need a registered agent to act as a point of contact in any state you operate. If you don't have staff to perform that role, you may need to pay someone to act as your registered agent.

You'll need to run payroll

A corporation must pay a salary to its employees, even if they're owners in the business. That requires the business to run payroll, issue pay stubs, and file payroll tax returns with the IRS and local tax authorities. It's common to use payroll services for these tasks, which incur fees.

Stock ownership restrictions

S corporation requirements and restrictions may limit your ability to raise capital by bringing in certain types of shareholders.

S corp vs LLC

Limited liability companies (LLCs) and S corporations both provide liability protection but differ in structure and taxation:

• LLC advantages: no board of directors required, flexible management structure
• S corp advantages: Potential self-employment tax savings for working owners
• Tax election option:LLCs can elect S corp tax treatment while maintaining LLC operational flexibility

S corp vs C corp

While both are corporations, S corps and C corps have key differences, especially in how they are taxed and who can own them.

The biggest difference is taxation. C corporations face "double taxation" where the business pays corporate income tax, and shareholders then pay personal income tax on dividends. S corporations are pass-through entities, meaning profits and losses pass directly to shareholders' personal tax returns, avoiding the corporate-level tax.

C corporations also offer more flexibility in ownership. They can have unlimited shareholders, including other corporations and foreign investors. S corporations are limited to 100 shareholders who must be US citizens or residents, and they can only issue one class of stock.

How to form an S corporation

Forming an S corporation creates a legal business entity with tax advantages, but you will need to follow several steps and may want professional guidance. The process typically takes 2–8 weeks and involves these key steps:

1. Choose a name: You'll need an official "entity name," which will be how your home state identifies you and addresses mail to you. If you use a different name with your customers, you'll need to register that as a "doing business as" (DBA) name. Both of these are done at a state level. To legally protect your name so that others can't use it, you'll need to trademark it with the United States Patent and Trademark Office.
2. Establish a board of directors: You'll need to elect a board of directors and schedule regular meetings. For small S corporations, directors are typically owners (and often also officers).
3. Issue stock to owners: Stocks must reflect the proportion of ownership, which in turn determines their share of annual profits. Stocks also authorize holders to elect board members and vote on corporate policies.
4. Appoint a registered agent: You need a registered agent to receive important legal and government correspondence on behalf of the business. They can be an employee of the business, or you can use a registered agent service.
5. File Articles of Incorporation form: This form spells out what the business does and how it will be managed. After you file this form, you'll need to settle on bylaws that set schedules and rules for board meetings.
6. File form 2553 with IRS: Once all your other paperwork has been approved, you'll need to submit Form 2553, "Election as a Small Business Corporation," signed by all shareholders, to the IRS.

Managing your S corp with the right tools

Running an S corporation (S corp) involves specific responsibilities, like processing payroll for owner-employees and keeping detailed financial records for tax purposes. Staying organized is key to maintaining compliance and making the most of your S corp status.

Xero simplifies these tasks with intuitive tools for payroll, expense tracking, and financial reporting. You can manage your books with confidence and get a clear view of your business performance in real time.

See how Xero makes it easy to run your business, not your books. It’s that easy with Xero. Get one month free.

FAQs on S corporations

Here are answers to common S corporation questions.

Are S corp earnings subject to self-employment tax?

No. However, owners who are employed in the business must draw a salary for the work they do, and that salary will be subject to both income and payroll tax. Profits that are distributed to owners are generally subject only to income tax.

Can a C corp become an S corp?

Yes, if a C corporation fulfills the requirements of an S corporation, it can file the relevant paperwork (Form 2553) with the IRS.

How do I know my business is eligible for S corporation status?

A business must be based in the US with no more than 100 existing shareholders (owners), all of whom must also live in the US. As a general rule, those existing shareholders need to be individuals. Learn more about IRS rules for S corporations.