What Is an S Corporation?

The Name Comes From the Tax Code, Not a State Filing

"S corporation" refers to Subchapter S of Chapter 1 of the Internal Revenue Code, the set of federal tax provisions that let certain corporations pass their income, deductions, and credits through to shareholders instead of being taxed at the corporate level first. No state issues an "S corporation" filing; every S corporation is, under state law, simply a corporation, formed the same way as any other by filing articles of incorporation.

How a Corporation Becomes an S Corporation

A business becomes an S corporation in two steps. First, it incorporates under state law like any other corporation, with articles of incorporation, a registered agent, bylaws, and issued stock. Second, it files IRS Form 2553, signed by every shareholder, electing S corporation tax treatment, generally due no more than two months and fifteen days after the start of the tax year the election should apply to. Until the IRS approves that election, the corporation is taxed as a regular C corporation.

Two Separate Legal Frameworks Apply at Once

An S corporation operates under two independent sets of rules simultaneously. State corporate law governs its formation, its board of directors and officers, its required meetings and minutes, and the liability protection it gives its owners, exactly as it would for any corporation. Federal tax law, specifically Subchapter S, governs how its income is taxed and who's allowed to be a shareholder. A change in one doesn't automatically change the other: revoking the S election, for example, doesn't dissolve the corporation or change its bylaws.

The Basic Tax Mechanism

Rather than paying corporate income tax on its own profit and having shareholders taxed again on dividends, an S corporation generally passes its income, deductions, and credits through to shareholders in proportion to their ownership, reported on Schedule K-1, and taxed once on the shareholders' personal returns. The corporation itself files an informational return, Form 1120-S, rather than paying tax on that income directly in most cases.

Basic Eligibility, in Brief

To qualify, a corporation can have no more than 100 shareholders, who must be individuals, certain trusts, or estates, not partnerships, corporations, or nonresident aliens, and it can issue only one class of stock. These rules apply continuously, not just at the time of the election; violating one can terminate S status. See our guide on S corporation ownership rules for the less commonly discussed ownership structures, like trusts and ESOPs, that still qualify.

A Former C Corporation Can Still Owe a Built-In Gains Tax

One detail that often surprises founders: electing S status doesn't automatically make a previously appreciated C corporation's built-in gains tax-free going forward. Under Internal Revenue Code Section 1374, a corporation that converts from C corporation to S corporation status can owe a corporate-level tax, at the top corporate rate, on built-in gains it recognizes within a five-year recognition period starting when the S election takes effect. This tax doesn't apply to a corporation that was an S corporation from its original formation, only to one that converted after operating as a C corporation with appreciated assets.

Why Businesses Choose S Status

An S corporation suits a profitable, closely held business whose ownership fits the eligibility rules and wants to avoid the double taxation a C corporation faces, while potentially reducing self-employment tax on an active owner's income by splitting it between salary and distributions. See our comparison of C corporations and S corporations for how the two differ in more detail.

The Election Is Revocable, but Not Casually

An S corporation can revoke its election, but doing so generally requires consent from shareholders holding a majority of shares, and re-electing S status again typically requires waiting five years without IRS consent. Treat the decision as a multi-year commitment.

State Tax Treatment Doesn't Always Mirror the Federal Rule

Most states follow the federal S corporation election for state income tax, but some states tax S corporations differently or require a separate state-level election. Check your specific state's treatment before assuming your state tax bill follows the federal pass-through result.

The Built-In Gains Tax Is a Trap for Converting, Appreciated Businesses

If you're converting an already-profitable, asset-rich C corporation to S status specifically to avoid future double taxation, model the built-in gains tax exposure on your existing assets first; selling appreciated property within five years of the election can still trigger a corporate-level tax.

This Is Not Tax Advice

Whether S corporation status fits your business, and how the built-in gains tax might apply to your specific assets, depends on your numbers and history. Talk to a tax professional before electing or converting to S corporation status.