An S corporation, defined under Subchapter S of the Internal Revenue Code, is a distinct entity that combines the legal benefits of incorporation with the tax advantages of a partnership. This classification enables a corporation to pass corporate income, losses, deductions, and credits to shareholders for federal tax purposes.

Advantages of an S Corporation

Key advantages include pass-through taxation, which prevents the issue of double taxation seen in C corporations. Additionally, S corporations provide limited liability protection to their shareholders, safeguarding personal assets from corporate debts and liabilities. The structure also allows for cash method accounting, a simpler approach compared to the accrual method required for C corporations.

Differences from Other Business Forms

Distinct from partnerships and sole proprietorships, S corporations must adhere to stringent IRS eligibility requirements. These include restrictions on the number of shareholders, who must be U.S. citizens or residents, and a prohibition against non-individual shareholders such as corporations and partnerships. Unlike LLCs, which offer flexibility in profit distribution, S corporations allocate income strictly according to ownership percentages.

These unique characteristics make S corporations a perfect fit for small to medium-sized enterprises, as they satisfy the need to optimize tax efficiency while maintaining the benefits of incorporation.