S Corporation Tax Essentials: Eligibility, K-1s & Basis Rules
Overview: S corporations combine the legal protection of a corporation with pass-through taxation like partnerships. This guide covers who can be an S corp, how the election works, how income flows through, fringe benefit limitations, basis rules, and how the AAA account works.
✅ What Is an S Corporation?
- Starts as a C corp by default; must file Form 2553 to elect S status.
- Income, deductions, credits pass through to shareholders via Schedule K-1.
- Shareholders pay tax on income whether or not it’s distributed.
✅ S Corp Eligibility Requirements
- Domestic corporation.
- Only eligible shareholders: individuals, estates, certain trusts. No nonresident aliens, partnerships, or corporations as owners.
- Max 100 shareholders (family members can elect to count as one).
- Only one class of stock — differences in voting rights are OK; no preferred stock.
✅ Making the Election
- File Form 2553; all shareholders must consent.
- File by 15th day of the third month (e.g., March 15 for calendar year) to be effective for that year.
- New shareholders don’t need to consent once election is valid.
✅ Termination of S Status
- Voluntary revocation by >50% shareholders.
- Failing eligibility rules (e.g., nonresident alien or C corp becomes shareholder).
- Excess passive income for 3 consecutive years if prior C corp E&P exists.
- Must wait 5 years to reelect if terminated.
✅ Pass-Through & Schedule K-1
- Income and losses allocated on per-share, per-day basis.
- Ordinary business income is not subject to SE tax for shareholders.
- Separately stated items include interest, dividends, Section 1231 gains/losses, charitable contributions, Section 179 deduction, etc.
✅ Fringe Benefits
- Deductible for non-shareholder employees and ≤2% shareholders.
- For >2% shareholders: costs are not deductible unless included in W-2 wages.
✅ Stock Basis & Debt Basis
- Basis starts with contributions + income items, increased by income, decreased by distributions, deductions, and nondeductible expenses.
- S corp shareholders do not include corporate debt in stock basis, but direct shareholder loans create debt basis.
- Losses limited to basis; excess suspended until basis restored.
✅ Accumulated Adjustments Account (AAA)
- Tracks accumulated income during S corp years.
- Distributions cannot reduce AAA below zero.
- Increases: ordinary income, separately stated income/gains (not tax-exempt).
- Decreases: losses, deductions, nondeductible expenses, distributions.
🔗 Helpful References
👉 Master your S corporation tax strategy — stay eligible, track basis, and avoid surprise taxes!
