S Corporation Definition and Legal Meaning

On this page, you'll find the legal definition and meaning of S Corporation, written in plain English, along with examples of how it is used.

What is S Corporation?

(n) An association or joint stock company which passes on the entire income to the shareholders directly otherwise than as dividend is known as S corporation. An S corporation is thereby exempted from payment of corporate income tax

History and Meaning of S Corporation

S Corporations get their name from Subchapter S of Chapter 1 of the Internal Revenue Code (IRC). This subchapter provides for a specific type of corporation that allows small business owners to avoid paying certain taxes. The S Corporation status was introduced in 1958 as a way to encourage the creation and growth of small businesses. S Corporations are similar to regular corporations in that they are a separate legal entity from their owners, but they are taxed differently.

With an S Corporation, the company's income is not taxed at the corporate tax rate. Instead, the company's profits are "passed through" to its shareholders, who then report these gains on their individual tax returns. This helps small business owners avoid "double taxation" (taxation of both the corporation and its shareholders). To be eligible for S Corporation status, a company must have no more than 100 shareholders, who must all be individual U.S. citizens or permanent residents, among other requirements.

Examples of S Corporation

  1. Jane and John run a small retail store that has an S Corporation status. The store made a profit of $50,000 this year, which is distributed to Jane and John. Each reports $25,000 on their individual tax returns, avoiding corporate taxes.

  2. ABC Inc. is a small technology firm that organized as an S Corporation. The company earned $1.5 million in profits last year. ABC Inc. must file a tax return, but they do not pay any corporate taxes. Instead, the $1.5 million is passed through to shareholders.

  3. A group of doctors start a medical practice and choose to register as an S Corporation. The medical practice made a $100,000 profit, which is split among the doctors. Each reports their share on their individual tax return and avoids paying corporate taxes.

Legal Terms Similar to S Corporation

  1. C Corporation - A C Corporation is a standard corporation that pays corporate taxes on its profits.

  2. Limited Liability Company (LLC) - An LLC is a hybrid legal entity that offers the liability protection of a corporation with the pass-through taxation of a partnership.

  3. Partnership - A partnership is a business entity formed by two or more people who share profits and losses. Each partner reports their share on their individual tax return, avoiding corporate taxes.