What is an S Corp Election? A Guide for Small Businesses

An S Corporation (S Corp) election is a choice a business makes to change its income tax classification. Most commonly, it involves certain corporations and limited liability companies (LLCs). 

Instead of being taxed as standard types of corporations, businesses are treated under special rules set forth by the Internal Revenue Service (IRS). These rules allow profits and losses to pass directly to the owners. It’s important to recognize that this doesn’t refer to a complete change in the type of business entity, but rather a shift in its tax designation. 

We’ve put together this article to take a closer look at S Corp elections. For entrepreneurs considering formation or restructuring, it is wise to get an understanding of the advantages, risks, and eligibility requirements, as these can differ by jurisdiction. Importantly, while the designation is unique to the U.S, there are similar models elsewhere. Therefore, this article takes a global perspective to provide international entrepreneurs with practical insights.

Understanding an S Corp Election

An S Corp election originates in U.S. federal tax law. It was introduced as part of the IRS code in order to provide small businesses with an alternative to traditional corporate taxation, helping them to more flexibly manage tax strategies.

By default, a corporation in the U.S is considered a C Corporation. This means it is taxed separately from its shareholders. In contrast, when a corporation files to be an S Corp, the company itself does not pay federal income tax. Rather, the profits and losses flow through to the shareholders’ personal tax returns.

It is important to recognize that an S Corp election is a tax designation. It’s not a separate legal structure. The underlying business remains either a corporation or, in some cases, an LLC. The only thing that really changes is the way the company’s income is reported and taxed. This makes it particularly appealing to small and medium-sized businesses that want to avoid the potential double taxation typically faced by C Corporations, in which profits are taxed at both the corporate and shareholder levels.

How an S Corp Election Works

In the U.S., the process involves filing IRS Form 2553. This form must be submitted within a specific timeframe. In most cases, this should be no later than two months and 15 days after the beginning of the tax year in which the election is to take effect. If it is approved, the business will then be treated as an S Corporation for tax purposes beginning that year.

For LLCs, this provides another layer of flexibility. While most LLCs are already treated as pass-through entities by default, owners can choose to elect S Corp status to alter the way self-employment taxes apply. In this situation, the LLC’s owners can pay themselves both a salary and distributions, potentially reducing the overall tax burden.

However, it’s important to understand that eligibility rules are strict. The business must have no more than 100 shareholders, all of whom must be U.S. citizens or residents. Shareholders must generally be individuals, not corporations or partnerships, and the company may only issue one class of stock.

Benefits of Electing S Corp Status

The primary benefit is pass-through taxation. Instead of the business paying corporate income tax, its profits and losses are reported directly on the personal tax returns of the shareholders. This structure avoids the risk of double taxation and often results in more efficient tax treatment for small businesses.

Another significant advantage is the potential for self-employment tax savings. Because shareholders who actively work in the business are considered employees, they must receive a reasonable salary, which is subject to payroll taxes. However, additional profits may be distributed as dividends, which are not typically subject to self-employment tax. This can lead to potential savings when handled correctly.

S Corp status can also enhance a business’s credibility. For clients, suppliers, and investors, this shift can send a message that there’s a higher level of formality and legitimacy compared to sole proprietorships or basic LLCs. 

Finally, the election provides flexibility for small and medium-sized businesses. This is because it allows for a good balance between corporate protections and tax efficiency.

Limitations and Requirements

It’s vital to understand that the S Corp elections do come with certain limitations. These include:

• Shareholder restrictions – The number of shareholders cannot exceed 100. All of these shareholders must also meet strict eligibility criteria regarding residency and legal status. Entities such as corporations, partnerships, and non-resident aliens generally cannot own shares. This is a key consideration for those exploring how to add a partner to a corporation​, as it affects who can join.
• Compliance obligations – Formal requirements by authorities also tend to increase. Compared to sole proprietorships or standard LLCs, an S Corporation must observe formalities such as issuing stock, holding shareholder meetings, keeping minutes, and maintaining corporate records. These requirements can add administrative complexity and cost.
• Ongoing costs – Administrative costs also tend to rise. Payroll systems must be maintained to pay salaries to active shareholders and additional tax filings are required. For some businesses, these expenses outweigh the benefits. 

Furthermore, from a global perspective, it is important to understand that S Corp status is unique to the U.S. However, other jurisdictions can offer pass-through taxation or hybrid structures with similar effects.

S Corp Election for LLCs

An LLC with an S Corp election is still legally an LLC. However, for tax purposes it is treated as an S Corporation. Some LLC owners consider this approach because it can reduce self-employment taxes without sacrificing the liability protections of the LLC.

The main advantage of this approach is the ability to divide income into salary and distributions. Salaries are taxed under payroll rules, while distributions avoid self-employment tax. However, owners need to carefully determine what qualifies as a “reasonable salary,” as underpayment can trigger penalties from tax authorities.

On the other hand, electing S Corp status may impose stricter administrative obligations than remaining a standard LLC. It also limits who may own shares, which may not align with long-term global growth plans if the LLC intends to attract outside investors.

When an S Corp Election May Be Right for You

This designation is generally most beneficial for businesses that are expecting to generate moderate to significant profits, particularly in situations where owners are actively involved in operations. Professional practices such as medical, legal, and consulting firms often find the option advantageous, as do small service-based businesses with relatively predictable revenue.

However, an S Corp election isn’t likely to suit every situation. Businesses expecting to reinvest most of their earnings into growth, companies with non-resident investors, or entities planning to issue multiple classes of stock may find a different structure more suitable—which is relevant to those looking into what is a sole proprietorship. Each case depends on the balance of tax benefits, ownership needs, and compliance capacity.

Steps to File an S Corp Election

The process begins with reviewing eligibility. Business owners must confirm that they meet the shareholder, stock, and residency requirements. Once this is confirmed, the next step is to complete IRS Form 2553, providing details about the company, its shareholders, and the desired effective date.

The form must be filed within the deadlines set by the IRS. Late filings may still be accepted in certain circumstances, but they typically require additional explanation. After the change takes effect, the company must maintain compliance through payroll filings, shareholder records, and annual tax submissions.

The rules governing this type of designation are complex. As a result, collaborations with business formation and compliance consulting services can be invaluable before and after making the change. Accountants and legal professionals can help companies identify whether the approach is appropriate and ensure ongoing compliance with all relevant requirements.

FAQs

What is an S Corp election?

An S Corp election is a tax designation that allows corporations and eligible LLCs in the U.S. to pass income, losses, deductions, and credits directly to their shareholders, avoiding double taxation.

Can an LLC file for an S Corp election?

Yes. An LLC can elect to be taxed as an S Corporation, allowing it to divide income into salary and distributions, potentially reducing self-employment taxes.

What are the main benefits of S Corp status?

Key benefits include pass-through taxation, potential tax savings on self-employment income, enhanced credibility, and flexibility for small businesses.

What are the disadvantages of an S Corp election?

Disadvantages include strict shareholder restrictions, higher compliance requirements, and additional administrative costs compared to simpler structures.

How do I file for S Corp status?

Business owners file IRS Form 2553 within the required timeframe. The form collects details about the company and its shareholders, and once accepted, the election applies for that tax year.

Is an S Corp election valid outside the U.S.?

The S Corp election is specific to the U.S. tax system. However, other jurisdictions may have comparable structures that provide similar benefits.

References

IRS. (2025, July 3). S corporation employees, shareholders and corporate officers. IRS. https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-employees-shareholders-and-corporate-officers 

SBA. (2025, March 7). Choose a business structure. SBA. https://www.sba.gov/business-guide/launch-your-business/choose-business-structure