What Is An S Corporation? (Benefits & Limitations)

An S corporation, also known as an S Corp, S-Corp, or S election, is a way for a small business to choose to be taxed as a corporation rather than a sole proprietorship or partnership. In many instances, a qualifying business operating as an S election can gain access to tax benefits to help lower the business and individual owner tax liability while increasing business profitability.

Benefit #1: Owner Taxed As Corporation - Not Sole Proprietor

One of the primary tax benefits of an S Corp is the ability to pass through income and losses to its shareholders rather than paying tax on the corporation's income at the corporate level. This allows the individual business owner(s) to pay tax on their share of the corporation's income at the individual tax rate, potentially resulting in a lower overall tax rate. In addition, any losses incurred by the corporation can be used to offset the shareholder's other sources of income, potentially lowering their overall tax liability.

Benefit #2: Owner Avoids Double Taxation

Another benefit of an S Corp is that it allows the business to avoid double taxation, which occurs when a corporation pays taxes on its income. Then the individual shareholders pay taxes on the dividends they receive from the corporation. With an S Corp, the business's income is only taxed once -- at the individual tax rate of the shareholders.

Benefit #3: Owner Access to Fringe Benefits

In addition, an S Corp may also provide tax savings through the use of fringe benefits. Certain fringe benefits, such as health insurance and retirement plans, may be provided to the shareholders as a tax-free benefit, significantly lowering the overall tax liability.

Limitations: Shareholders, Stock, and Income

It is important to note that filing taxes as an S-Corp has some limitations, and requirements must be met to maintain the S Corp tax election. For example, the business must have fewer than 100 shareholders, all of whom must be individuals, certain trusts, or estates. In addition, the business's stock cannot be publicly traded, and there are restrictions on the types of income the business can earn.

In conclusion, the tax benefits of an S Corp election can be significant for small business owners. By electing to be taxed as a corporation, the business can enjoy the benefits of pass-through taxation, avoid double taxation, and take advantage of tax-free fringe benefits. However, it is important to carefully consider the limitations and requirements of S Corp status before making this election. Tax planning with an expert can help you save in taxes by accurately filing an S Corp election and filing each year.