An S corporation, often called an S corp, is a type of business tax election that allows a company to combine the legal structure of a corporation with the tax benefits of a pass through entity. An S corp is not a separate type of business formed with the state. Instead, it is a tax status elected with the IRS, usually by an LLC or a corporation.
One of the main benefits of an S corp is how profits are taxed. Unlike a traditional corporation, an S corp generally does not pay federal income tax at the business level. Instead, profits and losses pass through to the owners and are reported on their personal tax returns. This can help avoid double taxation that occurs with C corporations.
S corps are especially popular with small business owners because they may reduce self employment taxes. Owners who actively work in the business are required to pay themselves a reasonable salary, which is subject to payroll taxes. Any remaining profit can be distributed to the owner as a distribution, which is not subject to self employment tax, though it is still subject to income tax.
There are rules and limitations to be aware of. S corps have restrictions on the number and type of shareholders, and shareholders must generally be U.S. individuals or certain trusts. Because of these rules and the added payroll and compliance requirements, an S corp is not the right fit for every business.
For many growing businesses, an S corp can offer meaningful tax savings when set up and managed correctly. It is always best to consult with a tax professional to determine whether an S corp election makes sense for your specific situation.