What Is an S Corporation? | Harvard Business Services, Inc.

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What Is a Delaware S Corporation?

When starting a business, choosing the right legal and tax structure can have a major impact on your company’s growth. One option worth considering is the Delaware S Corporation. An S corporation is not a separate type of business entity, but rather a tax election recognized by the IRS. Understanding the basics of S corporations and Delaware incorporation can help you decide whether this structure is the right fit for your business goals.

What is an S-Corp?

An S corporation, often called an S-corp, is a tax classification available to certain corporations and limited liability companies (LLCs). Unlike a traditional C corporation, an S corporation allows business profits and losses to “pass through” directly to the owners’ personal tax returns. This structure helps business owners avoid the double taxation commonly associated with C corporations, where income is taxed at both the corporate and individual levels.

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I called to have my S-Corp set up on a Wednesday, and everything was done by Thursday. Top-notch service!

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S-Corp Eligibility

Not every business qualifies for S-corp status. To be eligible, a company must meet specific IRS requirements.

Must file IRS Form 2553 in a timely manner to elect subchapter S status
Requires the approval of all shareholders
Cannot have more than 100 shareholders
Cannot have more than one class of stock
The entity must be a domestic corporation
Shareholders cannot be non-resident aliens
Shareholders cannot be other companies

Forming an S-Corp

To create an S-corp, you must first form an eligible business entity, typically a corporation or LLC. In Delaware, corporations can generally be formed as one of the following:

General Corporation: The most basic form of corporation, often referred to as a stock corporation or open corporation.
Close Corporation: A closely held corporation owned and managed by a small group of shareholders.
Public Benefit Corporation: A for-profit corporation that also commits to pursuing one or more public benefits identified in its Certificate of Incorporation.

Once your corporation is formed, you can then file Form 2553 with the IRS within 75 days of the formation date to elect for S-Corp tax status.

After the IRS approves your application, your corporation will not have to pay U.S. federal income taxes. Instead, the tax liability (or tax credit) will be passed through to the individual shareholders according to their ownership share of the S corporation.

Benefits of an S-Corp

S-corps offer several advantages that make them a popular choice for small and mid-sized businesses. Below are some of the benefits that make the S-corp structure attractive to business owners looking for both legal protection and tax efficiency:

Pass-through tax treatment - A Delaware S-Corp won't pay income taxes on its profits. Typically, this is passed through to the owners, who report the income on their personal taxes.
Investors can write off early losses - The S-Corp losses pass through to the shareholders and can be reported on their personal tax returns.
Avoids double taxation on dividends - As pass-through entities, S-Corps don't pay income taxes on profits. Only shareholders do.
Limited liability protection - Shareholders are not personally responsible for the corporation’s debts, lawsuits, or other financial obligations.
Can be a member of a single-member LLC or a multi-member LLC - LLCs have flexible membership rules, allowing them to be individuals or other businesses.
Can own shares of a C-Corp - There's no legal barrier preventing an S-Corp from owning a C-Corp.
Allowed to own 100% of a C-Corp - An S-Corp can own a C-Corp, but the S-Corp will lose pass-through taxation for profit from those shares.

Disadvantages of S-Corp Status

Although S corporations provide several tax and liability advantages, they are not the right fit for every business. Business owners should carefully consider these limitations before choosing an S-Corp structure.

Restricted to 100 shareholders - Unlike C-Corps, which can have an unlimited number of shareholders, S-Corps are limited.
Restricted to one class of stock - A Corp can have any number of classes of Stock. To maintain their tax status, an S-Corp can only have one.
Cannot own shares in another S-Corp - Ownership limitations for S corporations prevent them from being owned by other S-Corps.
Losses pass through to the shareholders - While owners can report income on their personal taxes, they will also have to report the losses.

S-Corp vs LLC vs C-Corp

Corporations and LLCs are separate legal entities that provide limited liability protection to their owners. If a General Corporation or Close Corporation elects S-corporation tax status, its shareholders generally must be U.S. citizens or resident individuals. In addition, S-Corps cannot generally be owned by partnerships, corporations, or nonresident aliens.

Corporations and LLCs also differ in their ownership and management structures. LLCs can be managed directly by their members (owners) or by designated managers. Corporations, however, typically operate through three levels of authority: shareholders, directors, and officers. Shareholders own the corporation, directors oversee major business decisions, and officers manage day-to-day operations. In Delaware, a single person may serve in all corporate roles.

Infographic: Requirements for S-Corporation Status

Here's a quick reference for the requirements of having S-Corp status for your corporation, along with the advantages and disadvantages.

S-Corp FAQs

Do I need to live in Delaware to form an S-Corporation there?

No. You do not need to live in Delaware to form a Delaware corporation or elect S-corporation tax status there. Many business owners choose Delaware, even if they operate in another state. However, if your business primarily operates outside Delaware, you are required to have a registered agent with a physical address in Delaware.

Can an LLC be an S-Corp?

While an LLC cannot become an S-Corp, an LLC can choose to be taxed like an S corporation. After electing S Corporation Tax Status and meeting the necessary S-Corp requirements, an LLC can file Form 2553 to achieve a similar tax outcome to an S-Corp. The LLC itself remains an LLC under state law, but it receives S-corp tax treatment for federal tax purposes.

Can an S Corporation Own an LLC?

Yes. An S corporation can own an interest in an LLC. S corporations have their own limitations and cannot be owned by other entities, but they can serve as owners for other entities.