What is an S-corporation?

The salary versus distribution issue is probably one of the most discussed parts of S-corp taxation.

An owner who works for the company generally needs to receive reasonable compensation for services performed. The remaining amounts may potentially be distributed to shareholders, subject to the applicable rules.

It's not simply:

"The company made $100,000, so I can take $100,000 as tax-free distributions."

That's an oversimplification.

Also remember that pass-through doesn't mean the income is tax-free. It generally means the tax treatment occurs at the shareholder level rather than the corporation generally paying federal income tax on the pass-through items itself.

The IRS has specific rules for S corporations, including shareholder eligibility, elections, allocations, compensation, and distributions.

I'd recommend reading the IRS S-corporation guidance before deciding whether it makes sense for your particular business.

One thing I'd add is that an LLC and an S corporation aren't necessarily competing entity types.

An LLC is a business entity created under state law. An eligible LLC can potentially elect to be taxed as an S corporation for federal tax purposes.

That's why you'll sometimes hear someone say, "I have an LLC taxed as an S-corp." It sounds contradictory at first, but they're talking about two different things: the legal entity and its federal tax treatment.

There are also eligibility requirements for an S corporation. The IRS generally requires an S corporation to be a domestic corporation with no more than 100 shareholders, and certain corporations and nonresident alien individuals cannot be shareholders.

So if you're an Indian citizen living in the US, don't assume your citizenship automatically determines whether you can own one. Your U.S. tax residency and immigration situation can matter, particularly because the S-corp rules specifically address nonresident alien shareholders.

That's something I'd confirm with a US tax professional before forming or restructuring a business.

I had the same confusion when I started my business.

The easiest way I understand it is that S-corporation isn't really a separate state-law business entity. "S corporation" refers to a federal tax status that an eligible corporation can elect by filing with the IRS.

The main attraction is generally pass-through taxation. Instead of the corporation generally being taxed at the federal level on its income in the same way as a regular C corporation, certain income, deductions and other tax items generally pass through to the shareholders and are reported on their individual tax returns.

There are also rules around shareholder-employees. If an owner works for the S-corp, you can't necessarily just take all the money as distributions and call it a day. The IRS has rules concerning reasonable compensation.

I also learned that not everyone can be an S-corp shareholder. The IRS has eligibility requirements, including restrictions on certain types of shareholders.

So I'd look at the S-corp as a tax classification/election, rather than thinking of it as another name for a company registration.

Given below are some of the advantages of an S Corporation: 

• Any business which are registered as an S corporation does not have to pay any federal taxes at the entity level. 
• An S corporation also helps in lowering the personal income tax of a business owner.
• S corp shareholders can receive corporate dividends, which are tax-free, and they can be company employees, earn salaries. 
• An S-Corp has a simple assets transfer process without any tax consequences or complex rules. 

Here are a few requirements for an S Corp that you should meet: 

• It must be located in the US. 
• An S Corp should only have one class of stock. 
• It should not have more than 100 shareholders. 
• Corporations, partnerships, and nonresident aliens are not eligible for the qualified shareholders.