An S corporation cannot be formed by foreign entities, partnerships, many types of trusts, or other corporations. Eligible shareholders are limited to individuals who are U.S. citizens or residents, certain estates, and specific trusts. Ineligible entities include insurance companies, certain financial institutions, and domestic international sales corporations (DISCs).
Shareholders may only be individuals, certain trusts, estates, and certain exempt organizations (such as a 501(c)(3) nonprofit). Shareholders may not be partnerships or corporations. Shareholders must be US citizens or residents.
IRS requirements for an S corp
There must be 100 or fewer shareholders. For the purposes of this count, family members can be treated as a single shareholder under specific circumstances. The shareholders must be individuals, certain trusts, or estates.
An S corporation is able to hire employees, but employees are not a requirement. S corporations get taxed the same as partnerships and sole proprietorships.
Shareholders have to be natural persons – exceptions to this rule include certain trusts, estates, and tax-exempt nonprofit organizations. In addition, shareholders of an S corporation have to be US citizens or US residents for federal tax purposes.
A foreigner that is a US resident alien can own an S-Corp. As per the IRS, a US resident alien is an individual that is not a US citizen or US national and who meets either “the green card test” or “the substantial presence test” for each calendar year.
The "2% rule" for S Corporations treats shareholders owning more than 2% of the company's stock (or voting power) differently for fringe benefits, classifying them like partners in a partnership, not regular employees; this means benefits like health insurance premiums paid by the S Corp must be included as taxable wages on their W-2, rather than being tax-free, though the shareholder can often deduct these premiums as an "above-the-line" deduction. This rule prevents them from participating in tax-advantaged Section 125 cafeteria plans, making benefits like Health FSAs unavailable on a pre-tax basis.
Even if an S Corp has no income, it must file IRS Form 1120S annually to maintain compliance. Filing establishes a tax record, prevents IRS assumptions about tax liability, and avoids penalties. Business expenses can still be deducted, potentially resulting in a loss that carries forward.
FAQs about S Corp salaries
If a shareholder isn't performing work for the company they will not be an employee and instead would receive a K-1 for passive income.
To qualify for S corporation status, the corporation must meet the following requirements:
The Companies Act sets the broad framework, but a person's ability to enter a contract, as per the Indian Contract Act, 1872, is also crucial. This is why a minor cannot directly become a shareholder. Entities like companies, LLPs, and even NRIs can also own shares, but they must follow specific rules and regulations.
S corporations cannot be owned by corporations, LLCs, partnerships or many trusts. This is not the case for LLCs.
S-Corp reasonable salary is the market-rate compensation you must pay yourself before taking distributions, typically ranging from $40,000-$150,000+, depending on your role, industry, and location. The IRS requires this to prevent payroll tax avoidance, with penalties reaching 20% plus interest for non-compliance.
Can my S-corp pay my personal taxes? No, an S-corp cannot directly pay your personal taxes. However, as an S-corp owner, you can pay yourself a salary, and the corporation can cover certain business expenses on your behalf.
Because of the one-class-of-stock restriction, an S corporation cannot allocate losses or income to specific shareholders. Allocation of income and loss is governed by stock ownership, unlike partnerships or LLCs taxed as partnerships, where the allocation can be set in the partnership agreement or operating agreement.
The IRS will not object to the S- Corp making zero payments to the owner employee when the business is earning little or no income. But, when the business is making money, it must first pay the owner-employee a reasonable compensation before making any payroll tax-free distributions with any excess funds.
No, an S Corp doesn't need two owners. A one owner S Corp is perfectly legal and quite common. The IRS allows S Corporations to have up to 100 shareholders, but there's no minimum requirement.
In your S corporation, your spouse is not a regular employee to whom you can provide all fringe benefits tax-free while deducting those expenses on your tax return. When your S corporation has your spouse as an employee, the tax code gives you a limited list of fringe benefits.
You choose an S corp over an LLC primarily for significant self-employment tax savings on profits, as S corp owners can pay a reasonable salary (subject to payroll taxes) and take remaining profits as distributions (not subject to self-employment tax). While an LLC offers flexibility, an S corp provides more structure, making it potentially better for larger profits or attracting investors, but it demands stricter formalities and compliance.
Double taxation refers to how income earned by C corps is taxed twice: once when the corporation earns income, and again when it distributes dividends to its owners (who then pay taxes on those dividends). S corps avoid double taxation by passing their income through to their shareholders directly.