S Corporation Interactive Guide
An interactive tool to understand S Corp taxation.
What is an S Corporation?
By default, a new corporation is taxed as a C Corporation, which leads to potential "double taxation" – the company's profits are taxed, and then the dividends paid to shareholders are taxed again on their personal returns. An S Corporation is a special tax election that allows a small, closely held corporation to avoid this. It's treated as a "pass-through" or "flow-through" entity, similar to a partnership. This means all income, gains, losses, and deductions are passed directly to the shareholders, who then report these items on their individual tax returns.
The Pass-Through Mechanism
Shareholders are taxed on their proportionate share of the S Corp's earnings each year, regardless of whether the earnings are actually distributed to them. This is a critical concept to understand. The business's financial activity flows through to the owners' personal tax situations, and the corporation itself generally does not pay federal income tax. The S Corp files an informational return (Form 1120S) and provides each shareholder with a Schedule K-1, which details their share of the various financial items.
S Corporation Eligibility Requirements
To qualify for S Corp status, a corporation must meet several strict requirements. Failing to meet any of these, even for a single day, can result in the termination of the S election.
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Be a Domestic Corporation
The entity must be a corporation formed within the United States.
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Have Only Allowable Shareholders
Shareholders must be individuals, certain trusts, or estates. Partnerships, corporations, and non-resident alien shareholders are generally not permitted.
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Have No More Than 100 Shareholders
For this purpose, members of a family may be treated as a single shareholder.
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Have Only One Class of Stock
This means all outstanding shares must confer identical rights to distribution and liquidation proceeds. Differences in voting rights are permissible.
Key Tax Advantages
The S Corp structure offers several significant tax benefits, primarily centered around avoiding double taxation and reducing self-employment taxes.
Pass-Through Taxation
Profits and losses are passed directly to shareholders, avoiding income tax at the corporate level.
Reduced Self-Employment Tax
Only the "reasonable salary" paid to a shareholder-employee is subject to FICA tax. Further profit distributions are not.
QBI Deduction
Shareholders may deduct up to 20% of qualified business income (QBI) on their personal returns.
Taxation: S Corp vs. C Corp
This chart illustrates the fundamental difference in how profits are taxed. C Corps face two layers of tax, while S Corps face only one layer at the shareholder level.
Shareholder Basis Calculator
A shareholder's "basis" is their financial stake in the company. It's crucial because it limits the amount of loss you can deduct. Your basis increases with income and contributions and decreases with losses and distributions. Use this calculator, based on the report's example, to see how it works. Your deductible loss is limited to your total basis (Stock + Debt).
Calculated Ending Stock Basis
$35,000
Accumulated Adjustments Account (AAA)
The AAA tracks the cumulative taxable income of an S Corp that has not yet been distributed to shareholders. It's essentially the S Corp's "retained earnings" for tax purposes. This chart shows how the AAA balance changes over three years based on the report's final example, highlighting the impact of a significant business loss in Year 2.
