A subchapter S corporation is a regular corporation created under state corporate laws. What makes it an S corporation (as opposed to a C corporation) is that the legal entity makes an election with the Internal Revenue Code to be taxed differently from the standard corp structure.
This election is is known as an S election and the corporation becomes taxed under a different set of tax laws found under Subchapter S of the Internal Revenue Code.
In effect, the business will not be taxed as a pass-through entity which means that the entity itself will not pay taxes on its income. Instead, it will just file an informational return and allocate the income tax burden to its shareholders based on their proportionate ownership interests.
The shareholders will then report their share of the corporation’s income on their own personal tax return and pay taxes based on their relative tax brackets.
The biggest benefit of a subchapter S qualification is that there is no double taxation.
Not every corporation can qualify to be taxed as a subchapter S corporation. The IRS imposes a laundry list of limitations and restrictions that the business and shareholders must not only meet but continue to comply with at all times. Failure to meet one, even if inadvertently, can result in significant tax liabilities. Check with your accountant for the latest set of requirements as they can change from year to year. Some of the major ones include: There must be less than 100 shareholders, the shareholders must all be natural persons (with limited exceptions), the shareholders must be based in the US, and there must only be one class of stock.
The benefit of this status is reduced taxation in most cases while still getting all the benefits of a corporation under state law. Of interesting note is that another legal entity alternative, the limited liability company, offers similar single layer taxation without all the requirements. You may want to consider comparing the two.