A corporation (or LLC that has elected to be taxed as a corporation) may elect to be taxed as a pass-through entity for US federal and certain state income tax purposes if it meets certain eligibility requirements. They include:
(i) having no more than 100 stockholders, all of whom are individuals, certain tax exempt organizations, qualifying trusts, or estates, and none of whom are nonresident aliens;
(ii) having only one class of stock (although options and differences in voting rights are generally permitted).
Like other pass-through entities, S corporations generally do not pay US federal income tax at the entity level, and their income and loss is treated as earned directly by the S corporation’s stockholders, subject to certain modifications and limitations. Note, however that S corporations are directly liable for some US taxes (including payroll taxes) and may be subject to entity-level taxes imposed by US state and foreign governments.
Stock originally received from an S corporation is generally ineligible for QSBS benefits, even if the corporation is subsequently taxed as a C corporation.
If an S corporation ceases to meet the eligibility requirements at any time, it automatically reverts to being taxed as a C corporation. The validity of a S corporation’s status as such often is a focus of diligence upon a future exit. You should consult your tax advisor before making an S election, and on an ongoing basis to ensure that S corporation requirements are met at all times.
Last reviewed: October 25, 2022