What is an S corporation?

Published Tuesday 12 May 2026

Table of contents

• What is an S corporation?
• S corporation requirements and eligibility
• Benefits of choosing an S corporation
• S corp considerations and limitations
• S corp vs LLC
• S corp vs C corp
• Is an S corp right for your business?
• How to form an S corporation
• S corp tax filing requirements
• Simplify your S corp finances with Xero
• FAQs on S corporations

Key takeaways

• An S corporation is a tax election, not a business entity type. It lets you keep the liability protection of a corporation while passing income directly to your personal tax return, avoiding double taxation.
• S corp owners who actively work in the business can save on self-employment taxes by splitting income between a reasonable salary (subject to payroll taxes at 15.3%) and distributions (which aren't).
• To qualify, your business must be a domestic corporation with no more than 100 shareholders, all of whom are U.S. citizens or resident aliens. You'll need to file Form 2553 with the IRS within two months and 15 days of the start of your tax year.
• S corps work best for profitable small businesses, typically those earning $60,000 or more in net income, that want tax savings without giving up legal protection.

What is an S corporation?

An S corporation (S corp) is a business structure that combines the liability protection of a corporation with pass-through tax treatment, meaning business income flows directly to the owners' personal tax returns. The "S" refers to Subchapter S of the Internal Revenue Code, which grants this special tax status.

Unlike a standard corporation (known as a C corp), an S corp doesn't pay federal income tax at the corporate level. Instead, profits and losses pass through to shareholders, who report them on their individual returns. This avoids the "double taxation" that C corps face, where income is taxed once at the corporate level and again when distributed as dividends.

An S corp isn't a type of business entity on its own. It's a tax election you make with the IRS after forming a corporation (or, in some cases, an LLC). Your state still treats the business as a regular corporation, with all the legal protections that come with it.

OK, so what's a corporation?

A corporation is a legal entity that exists separately from its owners. When you incorporate, your business becomes its own "person" in the eyes of the law, with the ability to own property, enter contracts, and take on debt independently.

The biggest benefit of this separation is limited liability. If the business runs into financial trouble or gets sued, your personal assets (your home, savings, and car) are generally protected.

Corporations are one of several ways to structure a business. Others include sole proprietorships, partnerships, and limited liability companies (LLCs). Each has different rules around taxation, liability, and management. The right choice depends on your business size, goals, and growth plans. You can compare all the options in the types of business structures guide.

S corporation requirements and eligibility

Not every business can elect S corp status. The IRS sets specific requirements you must meet and continue to follow for as long as you maintain the election.

To qualify as an S corporation, your business must meet all of the following criteria:

• Be a domestic corporation (formed in the U.S.)
• Have no more than 100 shareholders
• Have only U.S. citizens or resident aliens as shareholders (including certain trusts and estates)
• Issue only one class of stock
• Not be an ineligible corporation, such as certain financial institutions, insurance companies, or domestic international sales corporations

You'll also need to file Form 2553 (Election by a Small Business Corporation) with the IRS. The filing deadline is within two months and 15 days of the beginning of the tax year you want the election to take effect. For a calendar-year business, that means filing by March 15. If you miss the deadline, the election typically won't take effect until the following tax year.

All shareholders must sign Form 2553 to consent to the election. You can learn more about the process on the IRS S corporations page.

Benefits of choosing an S corporation

S corps offer a combination of tax advantages and legal protections that make them appealing to small business owners. Here's a closer look at the main benefits.

Pass-through taxation and self-employment tax savings

The biggest draw of an S corp is how it handles taxes. As a pass-through entity, the business itself doesn't pay federal income tax. Instead, profits flow through to your personal tax return, where you're taxed at your individual rate.

If you're an owner who works in the business, you can split your income into two categories: a reasonable salary and shareholder distributions. Your salary is subject to payroll taxes (Social Security and Medicare) at 15.3%, split between employee and employer portions. Distributions, however, aren't subject to self-employment tax.

For example, if your S corp earns $120,000 in profit and you pay yourself a reasonable salary of $70,000, only that $70,000 is subject to payroll taxes. The remaining $50,000 passes through as a distribution, saving you roughly $7,650 in self-employment taxes.

S corp shareholders may also qualify for the Qualified Business Income (QBI) deduction, introduced by the 2017 Tax Cuts and Jobs Act. This allows eligible business owners to deduct up to 20% of their qualified business income on their personal tax returns, subject to income thresholds and other limitations.

Personal asset protection

Because an S corp is a corporation, it provides limited liability protection. Your personal assets are generally shielded from business debts and lawsuits. If a customer sues the business or the company can't pay its bills, creditors typically can't go after your personal bank accounts, home, or other property.

This protection holds as long as you maintain proper corporate formalities, such as keeping business and personal finances separate, holding regular board meetings, and maintaining accurate records.

Business credibility and structure

Operating as an S corp gives your business a formal structure that can build credibility with customers, vendors, and lenders. Having "Inc." or "Corp." in your business name signals permanence and professionalism.

The corporate structure also adds financial discipline. You'll need to maintain separate bank accounts, follow bylaws, and keep detailed records. While that requires more effort than running a sole proprietorship, it creates better financial habits and clearer documentation as your business grows.

S corp considerations and limitations

S corps aren't the right fit for every business. Before choosing this structure, you should understand the trade-offs that come with it.

Here are the main considerations to keep in mind:

• Administrative requirements: S corps must follow corporate formalities, including holding annual meetings, maintaining bylaws, and keeping meeting minutes. These tasks take time and attention.
• Formation and ongoing costs: Filing articles of incorporation, drafting bylaws, and maintaining your status with the state all cost money. You may also need to pay for accounting, legal, and payroll services.
• Mandatory payroll: If you work in the business, the IRS requires you to pay yourself a "reasonable salary" before taking distributions. You'll need to run payroll, withhold taxes, and file payroll tax returns.
• Reasonable salary scrutiny: The IRS watches S corp salary-to-distribution ratios closely. A commonly referenced guideline is the 60/40 rule, where roughly 60% of your earnings go toward salary and 40% toward distributions. Setting your salary too low can trigger an audit and penalties.
• Stock restrictions: S corps can issue only one class of stock and are limited to 100 shareholders. This can make it harder to attract investors or offer different share types for fundraising.
• State tax variations: Some states don't recognize the S corp election or impose their own corporate taxes on S corps. Check your state's rules before making the election.

S corp vs LLC

S corps and LLCs are two of the most popular structures for small businesses, and they share several features. Both offer limited liability protection and pass-through taxation by default. But they differ in how they're formed, managed, and taxed.

Here's how the two compare across key areas:

Formation: An LLC is formed by filing articles of organization with your state. An S corp starts as either a corporation or an LLC, then files Form 2553 with the IRS to elect S corp tax status. The S corp path involves more paperwork from the start.

Tax treatment: Both structures pass income through to the owners' personal tax returns by default. The key difference is that LLC members pay self-employment tax on their entire share of profits (15.3%), while S corp owner-employees pay payroll taxes only on their salary. The remaining S corp income passes through as distributions, which aren't subject to self-employment tax.

Management flexibility: LLCs offer more flexibility in how you run the business. You can choose member-managed or manager-managed structures, and you have fewer formalities to follow. S corps require a board of directors, officers, bylaws, and annual meetings.

Self-employment tax savings: This is where S corps often come out ahead. If your business earns well above what you'd pay yourself as a salary, the tax savings on distributions can be significant. LLCs don't offer this split unless they elect S corp taxation.

Best use cases: An LLC works well if you want a simpler structure with fewer formalities, especially when you're starting out. An S corp makes more sense if your business is profitable enough that the self-employment tax savings outweigh the added costs and administration.

It's worth noting that an LLC can elect to be taxed as an S corp, giving you the simplicity of an LLC with the tax benefits of an S corp. You can explore the full comparison in the S corp vs LLC guide.

S corp vs C corp

S corps and C corps are both corporations, but they differ significantly in how they're taxed and who can own them. Your choice between the two often comes down to your growth plans and investor needs.

Taxation: The most significant difference is how income is taxed. C corps pay corporate income tax on their profits, and shareholders pay tax again on dividends they receive. S corps avoid this double taxation by passing income directly to shareholders' personal returns.

Ownership flexibility: C corps have no restrictions on who can be a shareholder or how many shareholders they can have. They can also issue multiple classes of stock, such as common and preferred shares. S corps are limited to 100 U.S. citizen or resident alien shareholders and one class of stock.

Investor considerations: If you plan to seek venture capital or bring on international investors, a C corp is typically the better fit. Most institutional investors and venture capital firms prefer C corps because of the flexibility to issue preferred stock and the ability to include foreign shareholders.

Tax rates: C corps pay a flat 21% federal corporate tax rate, which can be advantageous if you plan to reinvest profits in the business rather than distribute them. S corp income is taxed at the shareholders' individual rates, which can range from 10% to 37%.

Best use cases: S corps tend to work best for small to mid-sized businesses with a limited number of U.S.-based shareholders who want to avoid double taxation. C corps are better suited for businesses planning rapid growth, seeking outside investment, or operating internationally.

Is an S corp right for your business?

Choosing the right business structure depends on your income, growth plans, and how much complexity you're willing to manage. An S corp isn't the best fit for everyone, but it can offer real advantages in the right situation.

An S corp generally becomes beneficial when your net business income exceeds roughly $60,000 per year. Below that threshold, the administrative costs and payroll requirements may outweigh the tax savings from splitting income into salary and distributions.

Here are some questions to help you decide:

• Is your net business income high enough that self-employment tax savings on distributions will exceed the added costs of payroll and corporate formalities?
• Do you have 100 or fewer shareholders, all of whom are U.S. citizens or resident aliens?
• Are you planning to stay relatively small, or do you need the flexibility to issue multiple classes of stock and bring on outside investors?
• Are you seeking venture capital or international investors? If so, a C corp may be a better fit.
• Are you prepared to handle payroll, annual meetings, bylaws, and detailed record-keeping?

If you're currently operating as a sole proprietor or single-member LLC and your profits are growing, electing S corp status can be a straightforward way to reduce your tax burden without giving up the protections you already have.

How to form an S corporation

Forming an S corp involves setting up a corporation (or LLC) at the state level, then making a tax election with the IRS. Here are the steps to follow.

1. Choose a business name. Pick a name that's available in your state and meets your state's naming requirements. Most states require the name to include "Inc.," "Corp.," or a similar designator.
2. File articles of incorporation. Submit your articles of incorporation (or articles of organization if you're forming an LLC first) with your state's Secretary of State office. Filing fees vary by state.
3. Appoint directors and create bylaws. If forming a corporation, appoint a board of directors and draft bylaws that outline how your business will operate. If forming an LLC, draft an operating agreement instead.
4. Get an Employer Identification Number (EIN). Apply for an EIN from the IRS. You'll need this to open a business bank account, hire employees, and file taxes.
5. File Form 2553 with the IRS. Submit Form 2553 to elect S corp status. You must file within two months and 15 days of the beginning of the tax year you want the election to apply. For a new business on a calendar year, this means filing by March 15. All shareholders must sign the form.
6. Register for state and local taxes. Depending on your state, you may need to register for state income tax, sales tax, or other local taxes. Some states also require separate S corp election filings.

Once your S corp is active, you'll file Form 1120-S (U.S. Income Tax Return for an S Corporation) annually with the IRS. For more details on starting an LLC that elects S corp taxation, check the linked guide.

S corp tax filing requirements

Running an S corp comes with ongoing tax obligations beyond your personal return. Understanding these requirements helps you stay compliant and avoid penalties.

Here are the key filings and responsibilities for S corp owners:

• Form 1120-S: your S corp must file this annual information return with the IRS, reporting the business's income, deductions, and credits. The deadline is March 15 for calendar-year filers. While the S corp doesn't pay federal income tax on this return, it's still a required filing.
• Schedule K-1: the S corp issues a Schedule K-1 to each shareholder, showing their share of the business's income, deductions, and credits. Shareholders use this to report their portion on their personal tax returns.
• W-2 for owner-employees: if you work in the business, you must pay yourself a reasonable salary and issue a W-2. You'll withhold federal income tax, Social Security, and Medicare taxes just like any other employee.
• Reasonable salary documentation: keep records showing how you determined your salary. Research comparable salaries for your role, industry, and region. If the IRS questions your salary, documentation of your methodology can protect you.
• Quarterly estimated taxes: as a shareholder receiving distributions, you'll likely need to make quarterly estimated tax payments to the IRS (using Form 1040-ES) to cover income tax on your pass-through income.
• State filings: many states require their own S corp tax returns or annual reports. Some states impose a franchise tax or minimum tax on S corps, even though the federal government doesn't tax S corp income at the entity level.

Simplify your S corp finances with Xero

Managing an S corp means tracking income, running payroll, and staying on top of tax deadlines. Xero's online accounting software can help you handle all of it in one place.

With Xero, you can connect your bank accounts for automatic reconciliation, so every transaction is categorized and up to date. Profit and loss reports give you a clear view of your business's financial health, making it easier to plan distributions and document your reasonable salary.

Xero also integrates with Gusto for payroll processing, which is especially useful for S corp owner-employees who need to run regular payroll, withhold taxes, and generate W-2s. You can manage everything from salary payments to tax filings without switching between platforms.

Get one month free and see how Xero can simplify your S corp finances.

FAQs on S corporations

Here are answers to frequently asked questions about S corporations.

Are S corp earnings subject to self-employment tax?

S corp earnings themselves aren't subject to self-employment tax. However, if you work in the business, the salary you pay yourself is subject to payroll taxes (Social Security and Medicare at a combined 15.3%). Distributions you take beyond your salary aren't subject to self-employment or payroll taxes.

What is the difference between an S corp and an LLC?

An LLC is a business entity formed at the state level, while an S corp is a federal tax election. Both offer limited liability and pass-through taxation. The main difference is that S corp owners can split income between salary and distributions to reduce self-employment taxes, while LLC members typically pay self-employment tax on all profits. Learn more in the S corp vs LLC comparison.

What is the difference between an S corp and a C corp?

Both are corporations, but they're taxed differently. C corp income is taxed at the corporate level (21% flat rate) and again when distributed as dividends to shareholders. S corp income passes through to shareholders' personal returns, avoiding double taxation. C corps can have unlimited shareholders and multiple stock classes, while S corps are limited to 100 U.S.-based shareholders and one class of stock.

How are S corps taxed?

S corps are pass-through entities, meaning the business doesn't pay federal income tax. Instead, profits and losses flow through to shareholders' personal tax returns via Schedule K-1. Owner-employees must pay themselves a reasonable salary subject to payroll taxes, and they may also take distributions that aren't subject to self-employment tax.

Who should form an S corp?

An S corp works best for small business owners earning roughly $60,000 or more in annual net income who want to reduce self-employment taxes. It's a good fit if you have a small number of U.S.-based shareholders and don't need the flexibility to issue multiple stock classes or bring on foreign investors.

Can a C corp become an S corp?

Yes. A C corp can elect S corp status by filing Form 2553 with the IRS, as long as it meets all S corp eligibility requirements. The election must be filed within two months and 15 days of the start of the tax year. There are additional tax rules to be aware of during the conversion, including a built-in gains tax that may apply to appreciated assets for five years after the switch.