S-Corp: What is it and Should You Get One?

Updated: February 19, 2025

If you’re starting a business, you can choose to form sole proprietorships, general partnerships, LLCs, or corporations. Among these types of business entities, corporations are the most dynamic because they offer several significant advantages, including asset protection and limited liability.

Corporations are also the most secure entities to establish because they’re separate from their owners. Stockholders only have a stake in a corporation and cannot be held liable for the company’s debts or legal obligations.

Generally, a corporation can be taxed as a C corporation or an S corporation. This blog post will discuss what S corporations are, why they’re a smart choice for small business owners, and how to start one.

Defining a S Corporation

An S corporation, S-corp, or S subchapter is a corporation that’s considered a pass-through entity once it gains the status. Whenever an S corporation is taxed, its income goes to shareholders, bypassing federal corporate tax payments.

To convert your current business structure into an S-corp, you must elect the status with the Internal Revenue Service (IRS). Usually associated with small businesses (100 or fewer shareholders), S-corp status effectively gives a business the regular benefits of incorporation while enjoying the tax-exempt privileges of a partnership.

In short, an S-corporation is a type of tax status that offers tax benefits. We’ll discuss these advantages in the next section.

The Basic Requirements for S-Corp Status

Corporations must meet strict criteria set by the IRS to elect S corporation status. To qualify for this status, your business must:

• Be a corporation formed in the United States.
• Have shareholders categorized as:
  • Individuals
  • Certain trusts
  • Estates
• Not have partnerships, corporations, or non-resident alien shareholders. (For the latter, shareholders must be U.S. citizens.)
• Have no more than 100 shareholders.
• Hold one class of stock.
• It must be an ineligible corporation. Specific types of financial institutions, insurance companies, and domestic international sales corporations cannot elect S corporation status.

Why Start an S Corporation?

Forming an S-corp offers many benefits, including:

Asset Protection

S corporations provide asset protection if they incur debts or face legal action from plaintiffs. Moreover, they limit shareholder and owner liability for its debts and legal obligations. Asset protection can even prevent creditors from seizing personal assets to settle business debts.

Pass-Through Taxation

Instead of paying corporate taxes, S corporations “pass” any generated income or losses to shareholders. Both are included in a shareholder’s personal tax returns, with business losses compensating for other income declared on these documents. Newly established businesses can enjoy this benefit early on.

Tax-Favorable Classifications for Shareholder Income

If your S-corp has employees, they can receive salaries, dividends, and other tax-free shares corresponding to their stake in the business. The last two apply to employees who are the company’s shareholders.

With shares labeled as salary or dividends, S-corp owners and operators can pay fewer self-employment taxes while earning income and compensating employees and shareholders.

Easily Transferable Ownership

Over time, S-corp owners may decide to step down. In this case, their ownership can be transferred to other individuals or entities. The process has little impact on the company’s taxation, making modifying property basis or adhering to complex accounting rules unnecessary.

Increased Credibility

When a new business is formed as an S corporation, it can be viewed as a reputable venture. In turn, those engaging with the business see that its owners are committed to its operations and long-term growth.

What are the Disadvantages of Forming an S-Corp?

Despite offering multiple advantages for small business owners, S corporations have their drawbacks as well.

Costly to Start & Maintain

Before electing S-corp status, you must draft articles of incorporation and submit it to your Secretary of State or equivalent office. This step registers your corporation with your chosen state.

You’ll also need to hire a registered agent to accept important documents on your behalf and pay the necessary fees. Incorporation involves one-time and ongoing fees, with many of them being expensive. Conversely, sole proprietorships and general partnerships save on these considerable costs.

Taxation Requirements

S corporations must also meet the specific taxation requirements imposed on them, from election to filing obligations. Otherwise, their status may be downgraded to a C corporation. Such cases rarely happen, yet they should be considered when choosing business entities.

Stock Ownership Restrictions

While S corporations must hold one class of stock, they can hold and distribute voting and non-voting shares. Considering these factors, an S-corp’s investors must belong to the same category.

Additionally, S corporations can have up to 100 shareholders. Non-resident aliens, partnerships, and other corporations are discouraged from investing in these entities.

S-Corp vs. LLC: Weighing Your Options

Now that you have a better understanding of an S-corporation, it might be helpful to compare it to another popular business entity: the limited liability company (LLC).

Below, we’ve outlined these legal entities’ key similarities and differences.

Similarities Between S-Corps & LLCs

• LLCs and S-corps are pass-through entities. This means they don’t pay corporate taxes, and both offer limited liability protection for their owners or principals.

• Both business structures become separate legal entities when required documents are filed with their home state. For a corporation to become an S-corp, it must file IRS Form 2553 with the IRS.

• S-corps and LLCs must comply with the specific regulations imposed on them. Both businesses are required to:
  • Designate and manage their registered agent.
  • Submit annual reports and pay annual fees (if applicable) charged by their home state.
  • Inform their home state of changes to existing business information.
  • Meet specific requirements to do business in other states.

Differences Between S-Corps & LLCs

• LLCs are more flexible than S-corporations because they aren’t subject to the IRS’s compliance and ownership requirements. For example, LLCs can have as many members as their owners wish, whereas S-corporations can only have up to 100 shareholders.
• Another key difference between S-corporations and LLCs is management. While members or managers can manage LLCs, S-corporations have directors and officers.
  • S-corp directors focus on corporate matters and decision-making.
  • Officers handle the company’s daily operations.
• S-corps are obligated to follow internal formalities by law. This is generally unnecessary for LLCs, although experts advise them to do so.
  • At the very least, S-corps must adopt bylaws, issue stock, hold director and shareholder meetings, and store meeting minutes in corporate records.
  • LLCs must draft and implement an operating agreement, distribute member shares, hold and record member or manager meetings, and record any major decisions.

How to Start an S Corporation: Step-by-Step

To create an S corporation, you’ll need to:

1. Form a corporation by filing articles of incorporation with your state. It’s also important to pay the required filing fees, taxes, and other applicable fees.
2. File Form 2553 with the IRS. The document states that your business can only gain S-corp status if it meets all its qualifications.
3. Appoint a registered agent. Individuals and businesses can act as your S corporation’s registered agent.
4. Apply for an Employer Identification Number (EIN) if you plan to hire and manage employees.
5. Obtain the necessary business licenses and permits from your home state.
6. File a beneficial owner information (BOI) report with the U.S. Department of Treasury’s Financial Crimes Enforcement Network.
7. Hold an initial directors meeting to implement bylaws and initiate other crucial responsibilities.

Conclusion

When forming an S-corp, you protect yourself and your assets from threats like lawsuits. It can even free you from paying corporate taxes and help you build credibility as an entrepreneur, showing consumers and potential partners that you’re serious about doing business.

Looking past these benefits of S-corps, though, starting one can take most of your time or effort. Inc Authority is here to guide you through the incorporation process. We’ll check business name availability, register your S-corp, and obtain an EIN. Once your business is formed, you can add relevant services to help simplify your day-to-day operations.

Incorporating is the most powerful thing you can do to legitimize your business. And at IncAuthority.com, our setup LLC services are 100% free. Always. So, don’t wait. Form your free LLC today and enjoy the protection due to you and your business under the law.

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