Key Takeaways

  • The main benefits of an S corp include pass-through taxation, limited liability, and potential savings on self-employment taxes.
  • S corps provide credibility with investors, lenders, and customers due to their formal structure and transparent governance.
  • They allow business owners to classify income as salary and dividends, optimizing tax outcomes.
  • Shareholders enjoy liability protection without being taxed twice on business income.
  • S corps must follow IRS rules—such as limits on shareholders and stock classes—to maintain their tax status.

There are many S corporation advantages for your business. The term S corporation or S corp gets its name from the IRS S election, a type of taxation which requires that shareholders pay taxes at the individual level. This allows the business to avoid the double taxation it would be subject to as a regular corporation. 

What Is an S Corporation?

To further define the concept, an S corporation is a regular corporation treated as a pass-through entity under federal tax rules and is elected through the Internal Revenue Service (IRS). S corporations don't pay taxes at the corporate rate. Instead, profits and losses are passed through to shareholders who report these on their personal income tax returns.

Forming an S corporation is similar to forming an ordinary corporation with an Article of Incorporation submitted to the Secretary of State or similar agency. Business owners have the same liability protection as shareholders of a regular corporation. Shareholders' personal assets can't be seized to satisfy business debts and liabilities.

Which Companies Can Qualify as S Corporations?

There are a few requirements that have to be met before a business can get S corporation status. The business  must demonstrate that:

  • Shareholders are permanent residents or hold U.S. citizenship 
  • There are no more than 100 shareholders
  • It only has one class of stock

If your business can satisfy these criteria and you are considering converting it to an S corporation, take note of the deadlines for processing your application with the IRS. When forming a new business, you are only allowed to file IRS Form 2553 within 75 days from the date of incorporation.

Advantages of an S Corporation

S corporation status is an option most business owners consider when starting a new business. There are advantages an S corporation offers when compared to other business types.

  • Shareholders' personal assets are protected.
  • Federal taxes are not paid on the corporate level, saving the business from possible double taxation.
  • Shareholders can also be employees of the business which means they can receive salaries apart from their dividends and other tax-free distributions.
  • An S corporation can easily be converted into a C corporation.
  • Shareholders and management are covered by limited liability protection.
  • There are no state residency requirements.
  • S corp status allows for pass-through taxation which means that income is distributed to the shareholders, where tax payment is applied at the personal level.
  • There is stronger credibility with customers, partners, investors, lenders, and employees as an S corp when compared to sole proprietorships.
  • There is high income-splitting potential for shareholders and employees.
  • S corp status doesn't require large start-up costs or major equipment purchases and contracts.

Ownership Flexibility and Business Continuity

S corporations also provide continuity of existence. Unlike sole proprietorships or partnerships, an S corp continues to operate even if a shareholder leaves or sells their shares. This continuity helps preserve the company’s identity and operations over time.

Although ownership is limited to 100 U.S. citizens or residents, this still provides flexibility for closely held businesses, family-run companies, and small groups of investors. Transferability of shares also allows owners to plan for succession or retirement without dissolving the business.

Protection of Personal Assets and Limited Liability

A core benefit of an S corp is the liability protection it offers. Like traditional corporations, S corporations establish a legal separation between the business and its shareholders. This means that personal assets—such as homes, vehicles, and personal bank accounts—are typically protected from lawsuits or business debts.

As long as corporate formalities are followed (such as maintaining separate bank accounts, records, and meeting minutes), shareholders are shielded from personal responsibility for company liabilities.

Enhanced Credibility and Investment Appeal

Another major advantage is the credibility that comes with operating as an S corporation. The structure signals to clients, lenders, and investors that your business adheres to formal legal and financial standards. It shows that the business is organized, compliant, and transparent—qualities that can open doors to better financing and partnership opportunities.

Additionally, the issuance of stock—albeit limited to one class—allows for an organized equity structure. This makes it easier to attract investors, issue ownership stakes, and manage succession planning without undermining corporate governance.

Tax Efficiency and Self-Employment Tax Savings

One of the most notable benefits of an S corp is its favorable tax treatment. Unlike C corporations, S corporations avoid double taxation—profits and losses pass directly to shareholders and are taxed only at the individual level. This structure not only simplifies tax reporting but can also reduce the overall tax burden.

In particular, shareholder-employees can receive both a reasonable salary and dividend distributions. While salaries are subject to employment taxes, distributions are not, which can lead to significant savings on self-employment taxes. However, the IRS requires that S corp owners pay themselves a “reasonable salary” for the work they perform to ensure compliance.

This income-splitting flexibility is often a deciding factor for small business owners transitioning from sole proprietorship or partnership models to S corp status.

Disadvantages of an S Corporation

On the other hand, there are also disadvantages and risks involved in having a business registered under S corporation status.

  • For an S corporation to operate, the business needs to be incorporated. This requires filing Articles of Incorporation in the desired state, getting a registered agent, and paying the necessary fees.
  • Mistakes related to the business structure like elections, stock ownership, notification, consent, and other filing requirements can result in a cancellation of S corporation status. 
  • An S corporation is mandated to use the calendar year as its tax year unless it can propose a business purpose for following a fiscal year model.
  • S corporations are only allowed to offer one class of stock. There can be no more than one class of investors.
  • The number of shareholders is limited to 100, which can limit growth.
  • Foreign ownership is not allowed, and there are a lot of rules concerning ownership of trusts and other entities.
  • S corporation accounting can be more involved and require greater legal oversight when compared to sole proprietorships.
  • Fringe benefits offered by the corporation to employee-shareholders who hold more than 2 percent of the corporation are subject to tax.
  • Because of the one-class stock requirement, income or losses are difficult to allocate to specific shareholders.

Having a business established under S corporation status has advantages and disadvantages. It is better for business owners to examine all of these factors in order to maximize income for their business.

Compliance and IRS Scrutiny

Despite the tax and liability advantages, S corporations must comply with several administrative requirements. The IRS closely monitors reasonable salary practices and stock classification rules. Missteps—such as failing to file Form 2553 on time, creating a second class of stock, or including ineligible shareholders—can lead to termination of S corp status.

S corporations are also subject to strict recordkeeping and reporting requirements, such as maintaining meeting minutes, issuing stock certificates, and filing annual reports. These corporate formalities can increase legal and accounting costs compared to simpler business structures like LLCs or sole proprietorships.

Frequently Asked Questions

  1. What are the primary benefits of an S corp?
    The main benefits include pass-through taxation, limited liability protection, self-employment tax savings, and enhanced business credibility.
  2. How does an S corp save money on taxes?
    Owners can pay themselves a salary (subject to payroll taxes) and receive additional profits as distributions, which are not subject to self-employment tax.
  3. Are there limits to S corp ownership?
    Yes. S corps are limited to 100 shareholders, and all must be U.S. citizens or residents. Only one class of stock is permitted.
  4. Can an LLC elect to become an S corp?
    Yes. An LLC can elect S corp taxation by filing IRS Form 2553 if it meets the eligibility requirements.
  5. What happens if an S corp fails to follow IRS rules?
    The IRS can revoke S corp status, causing the business to be taxed as a C corporation, which may result in double taxation.

If you need help with S corporation filing, or want to discuss the pros and cons of S corp status, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.