What Is an S-Corp? Benefits and Drawbacks for Small Businesses
Introduction
If you’re a small business owner looking to reduce taxes while enjoying the legal protections of an LLC or corporation, the S-Corporation (S-Corp) could be worth considering. In 2025, this election status remains one of the most popular tax elections for profitable small businesses.
However, despite the name, this tax designation is not a separate business entity type — it’s an IRS tax designation you apply for after forming an LLC or Corporation. While it offers meaningful tax advantages, it also comes with compliance requirements and limitations that don’t work for every business.
This guide breaks down what an S-Corp is, how it works, and whether it might be the right choice for your company.
Key Features of an S Corporation
-
Pass-through taxation: No federal corporate income tax; profits pass through to owners and are taxed individually.
-
Salary + distributions: Owners can pay themselves a reasonable salary and receive additional profits as dividends.
-
Shareholder restrictions: Limited to 100 shareholders, all of whom must be U.S. citizens or residents.
-
Legal structure requirement: You must first form an LLC or corporation before electing S-Corp status. For guidance on entity selection, check out our guide to choosing the right business structure.
Benefits of the S Election for Small Businesses
-
Lower self-employment taxes – Split income between salary and dividends to reduce tax liability.
-
Avoid double taxation – Unlike C-Corps, profits aren’t taxed at both corporate and personal levels.
-
Liability protection – Safeguards personal assets from business debts and claims. Learn more in our small business legal protection guide.
-
Business credibility – Can help with funding, contracts, and business banking.
-
Flexible compensation – Allows for salary plus profit distributions.
Drawbacks of Choosing S-Corp Status
-
IRS compliance: Must file IRS Form 2553 within 75 days of formation or the start of a tax year.
-
Payroll required: Owners working in the business must be paid a reasonable salary.
-
More paperwork: Annual reports, tax filings, and bookkeeping must meet corporate standards.
-
Shareholder limitations: No foreign or corporate shareholders allowed.
How to Become an S-Corporation
-
Form an LLC or corporation in your state.
-
Obtain an EIN if you don’t already have one.
-
File IRS Form 2553 to elect S-Corp status within the required timeframe.
-
Maintain compliance: Process payroll, file quarterly taxes, and complete year-end returns. For more steps, see our ultimate legal checklist for starting your business.
❓ FAQ: S-Corp Basics
1. Is an S-Corporation better than an LLC?
It depends. The election can cut self-employment taxes but adds compliance.
2. Can any business elect S-Corp status?
No — you must meet IRS eligibility rules, including the 100-shareholder limit and U.S. ownership requirement.
3. What happens if I miss the 75-day filing deadline?
You may need to wait until the next tax year or request late election relief from the IRS.
4. Do S-Corps work for startups?
Sometimes, but if you plan to raise venture capital, investors typically prefer a C-Corp structure.
📌 Conclusion
An S-Corporation can be a powerful tax-saving tool for small business owners earning enough to pay a reasonable salary. The benefits are substantial for the right business, but the compliance obligations and ownership restrictions mean it’s not for everyone.
If you’re unsure whether S-Corp status fits your business, get tailored advice before filing with the IRS. For broader insight, review our guide to choosing the right business structure.
👉 Book a free 15-minute consultation with The Law Spot: Schedule Here
Last Updated: July 31, 2025