An S corporation is a corporation that elects to be treated as a pass-through entity (like a sole proprietorship or partnership) for tax purposes. Since all corporate income is "passed through" directly to the shareholders who include the income on their individual tax returns, S corporations are not subject to double taxation. Moreover, the accounting for an S corporation is generally easier than for a C corporation.
The following restrictions are placed on S corporations:
- Must not have more than 100 shareholders, and each of them must consent. (A married couple is treated as one shareholder)
- Each shareholder must be an individual who is a U.S. citizen or legal resident, or an estate or qualifying trust of such person
- Can only have one class of stock. (However, voting differences within a class of stock are permissible.) Preferred stock is not allowed
- Must use the calendar year as its fiscal year, unless it can demonstrate to the IRS that another fiscal year satisfies a business purpose
- Not more than 25% of its income can be "passive income" (such as rental income, interest, and royalties) over three continuous years
Corporations wishing to become an S corporation must file Form 2553 with the IRS. Each shareholder must sign the form. LegalZoom can complete this form for you and help you convert your business to an S corporation.