Interactive Guide to S Corporation Taxation
An explorable guide to understanding the core tax concepts of an S Corporation, from shareholder basis to distributions and limitations.
What is an S Corporation?
An S Corporation is a special type of corporation that elects to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. This structure allows a business to enjoy the liability protection of a corporation but avoid the double taxation inherent in C Corporations. Shareholders report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This section highlights the foundational principles of this tax structure.
Flow-Through Taxation
The core benefit. The S Corp itself is not taxed on its profits. Instead, all income, gains, losses, and deductions are "flowed through" to the shareholders, who are taxed individually. This avoids the C Corp issue of taxing profits at the corporate level and again when dividends are paid.
Shareholder Basis
A shareholder's tax basis is a critical account. It tracks their investment and is adjusted annually. Basis determines the taxability of distributions and the amount of corporate losses a shareholder can deduct. It includes both stock basis and debt basis (from direct loans).
Tax-Free Contributions
Under Sec. 351, contributing property for stock is generally tax-free if the contributors control 80% or more of the corporation after the transfer. This allows for business capitalization without triggering immediate tax liability for the shareholders.
QBI Deduction
Shareholders may be eligible for the Section 199A Qualified Business Income (QBI) deduction. This can allow for a deduction of up to 20% of the business income passed through from the S Corp, significantly lowering the shareholder's effective tax rate.
Corporate Level Taxes
While generally exempt, S Corps that were previously C Corps can face taxes like the Built-in Gains (BIG) tax or the Passive Investment Income tax. These rules prevent C Corps from avoiding taxes by simply converting to an S Corp.
Strict Eligibility
To maintain S Corp status, a corporation must meet several requirements, such as having no more than 100 shareholders, only one class of stock, and only eligible shareholders (individuals, certain trusts, and estates).
Shareholder Basis Calculator
A shareholder's basis is fundamental in an S Corporation. It limits the amount of losses you can deduct and determines whether distributions are taxable. Basis is calculated separately for stock and for any direct loans you make to the corporation. Use this calculator to see how different events during the year affect your ending stock and debt basis.
Enter Your Data
Calculated Basis
Ending Stock Basis
$54,000
Ending Debt Basis
$40,000
Total Tax Basis for Loss Deduction
$94,000
Stock Basis: Begins at $60,000, increases by $20,500 (income), and decreases by $26,500 (distributions & deductions).
Debt Basis: Begins at $50,000 and decreases by $10,000 (repayments).
Note: Losses first reduce stock basis to zero, then debt basis. Subsequent income restores debt basis first, then stock basis.
Distribution Waterfall Simulator
The tax treatment of an S Corporation distribution depends on two key factors: your stock basis and whether the corporation has accumulated Earnings & Profits (E&P) from a time it was a C Corporation. This simulator visualizes how a distribution is taxed based on these factors. Distributions are generally tax-free up to your basis, unless they are classified as taxable dividends from C-Corp E&P.
Set Scenario
Distribution Treatment
Loss Limitation Explorer
One of the benefits of an S Corp is passing losses to shareholders to offset other income. However, this is not unlimited. A shareholder's ability to deduct a loss is primarily limited by their tax basis (stock and debt basis combined). This tool demonstrates how the basis limitation works. Any losses you can't deduct in the current year are suspended and carried forward to future years.
Enter Loss Scenario
Loss Treatment Results
Total Basis Available for Losses
$40,000
Deductible Loss This Year
$40,000
Suspended Loss (Carried Forward)
$35,000
Explanation: Your total tax basis of $40,000 is the limit for deductible losses. Since the $75,000 loss exceeds this, only $40,000 is deductible now. The remaining $35,000 is suspended and can be used in future years once you have more basis (e.g., from future income or contributions).
Your stock and debt basis are both reduced to $0 by the deductible loss.
Corporate Lifecycle Events
An S Corporation's journey has distinct tax implications at each stage, from its creation to its potential termination or liquidation. The rules governing these events are critical for proper tax planning and compliance. This section provides a high-level overview of the key considerations at each phase of the S Corporation lifecycle.
1. Formation & Election
A new corporation defaults to a C Corp. To become an S Corp, a valid election must be filed (Form 2553). Contributions of property in exchange for stock are generally tax-free under Sec. 351 if the contributors own at least 80% of the stock afterward. The corporation takes a carryover basis in the contributed property.
2. Operation
During operation, all income, losses, and deductions are allocated to shareholders on a per-share, per-day basis. Shareholders' stock basis is adjusted annually for these items and for any distributions. The company files an informational tax return (Form 1120-S), and shareholders receive a Schedule K-1 detailing their share of all items.
3. Termination
S status can be terminated voluntarily (by a majority shareholder vote) or involuntarily (by failing to meet eligibility requirements, like having too much passive income for 3 straight years while holding C-Corp E&P). A termination can result in two short tax years (one S-Corp, one C-Corp). After termination, a business generally must wait five years to re-elect S status.
4. Liquidation
Liquidation is treated as if the corporation sold all its assets at fair market value. The corporation recognizes gain or loss on this deemed sale, which flows through to shareholders and adjusts their basis. Shareholders then treat the liquidating distribution as a payment in exchange for their stock, recognizing a capital gain or loss equal to the difference between the value received and their final stock basis.