S corporations elect to pass corporate income, losses, deductions, and credit through to their shareholders for federal tax purposes. S status combines the legal environment of C corporations with partnership-like federal income taxation.
Like a C corporation, an S corporation is generally subject to the laws of the state in which it is organized. However, in the manner of a partnership, an S corporation's income, deductions, and tax credits flow through annually to shareholders, regardless of whether distributions are made. Thus, income is taxed at the shareholder level and not at the corporate level, and payments are distributed to S shareholders tax-free to the extent that the distributed earnings were not previously taxed.
Certain corporate penalty taxes (e.g., accumulated earnings tax, personal holding company tax) and the alternative minimum tax do not apply to an S corporation. Unlike a C corporation, an S corporation is not eligible for a dividends received deduction, nor is it subject to the ten percent of taxable income limitation applicable to charitable contribution deductions.
In order to be eligible for S corporation status, a corporation must meet certain requirements:
- Be an eligible entity (a domestic corporation, or a limited liability company which has elected to be taxed as a corporation)
- Have only one class of stock
- Have no more than 100 shareholders
- Spouses are automatically treated as a single shareholder. Families, defined as individuals descended from a common ancestor, plus spouses and former spouses of either the common ancestor or anyone lineally descended from that person, are considered a single shareholder as long as any family member elects such treatment.
- Shareholders must be U.S. citizens or residents and natural persons, so corporate shareholders and partnerships are generally excluded. However, certain trusts, estates, and tax-exempt corporations, notably 501(c)(3) corporations, are permitted to be shareholders.
- Profits and losses must be allocated to shareholders proportionately to each one's interest in the business.
Pieter Brueghel the Younger, Paying the Tax (The Tax Collector)
S corporations are not burdened with double taxation.