How Are S Corporations Taxed By The IRS?

By Brendon Pack, Vice President at 1-800Accountant

Corporations are found in all shapes and sizes. From farming to technology to entertainment, corporations represent a part of every industry in the world. If you have the entrepreneurial energy to launch your own corporation, you should take ample time to consider which type of corporate entity to set up. One option is to establish an S corporation.

When it comes to IRS taxes, an S corporation does not pay any federal corporate income taxes as a C corporation does. However, this doesn’t mean it is exempt from taxation like a tax-exempt 501(c)3 non-profit. Rather than incurring corporate income taxes, an S corporation elects to have all of its income, losses, credit, and deductions passed directly through to its owners – or shareholders. The shareholders are then required to report all of this information on their personal income tax returns. Because of this, the shareholders are taxed according to their personal income tax rates, which could vary from one taxpayer to another. S corps are structured this way to help their owners avoid double taxation on the business income they generate.  Owners of S corporations are typically responsible for paying taxes on passive income and any built-in gains within the business.

 

To receive S corporation status from the IRS, a small business must meet several requirements. First and foremost, a business must be based domestically in the United States. It can only have allowable shareholders that include individuals or certain types of trusts and estates. S corporations cannot be established through partnerships or non-resident alien shareholders. In addition, S corps can have a maximum of 100 shareholders involved. They can have one class of stock as well.

 

Let’s say you currently operate an informal sole proprietorship or general partnership. If you want to gain credibility and protection by turning your small business into an S corporation, a business must file Form 2553 with the IRS. When reporting gains and losses in your S corp, you must file Form 1120S.