The US S-Corporation: Why the Letter S Exists, How to Elect It, What It Saves — and Why Foreigners Cannot Use It

The S-corporation is the most misunderstood entry on this list, because it is not a company. It is an election. An LLC or a corporation that makes it is still exactly what it was under state law; only the federal tax treatment changes. WHAT IT IS An S corporation is a corporation (or a qualifying LLC) taxed as a pass-through: the entity pays no federal income tax and its profit, losses and credits flow to its owners. The price is a list of rules: - At most 100 shareholders. - All shareholders must be US citizens or residents who are individuals (plus certain trusts, estates and similar permitted owners). No non-resident aliens, no partnerships, no corporations. - Only one class of stock. - Some states require a separate election; a few tax the income anyway. WHERE THE NAME COMES FROM The letter is not an acronym — it is a filing position. In 1958 the Technical Amendments Act created a lighter corporate tax regime for small businesses and placed it in Subchapter S of Chapter 1 of the Internal Revenue Code. Subchapters are lettered in order and Subchapter C already held the default corporate rules, so the new regime took the next letter. The default became the "C corporation" and the election the "S corporation", purely by position in the alphabet. The link to "small" survives in the code itself: an S corporation is defined as a corporation meeting section 1361(a)(1), which describes a "small business corporation". There is no S entity registered with any state, no certificate of S incorporation, and no line on a bank form: you form an LLC or corporation, then choose a tax treatment. HOW TO ELECT IT 1. Start with an eligible entity — a corporation, or an LLC (which keeps its members, operating agreement and no board). 2. Confirm every owner is eligible before filing, and that there are no more than 100. 3. File Form 2553, signed by every shareholder. Generally due by the 15th day of the third month of the tax year it applies to, or any time in the preceding year; a new entity electing for its first year must file within two months and 15 days of formation. Late relief exists but is not a plan. 4. Get an EIN, register for payroll, and put owner-employees on payroll. 5. Check your state: some require an equivalent state election, and some (California) tax the income regardless. 6. Stay compliant. One ineligible shareholder, a second class of stock, or a transfer to a foreign owner terminates the election — possibly retroactively — and re-electing is blocked for five years. HOW TO RUN IT Form 1120-S by 15 March (calendar year) with a Schedule K-1 per shareholder. Owner-employees must be paid a reasonable salary through payroll: W-2s, Forms 941, deposits, state unemployment insurance. Distributions above the salary are not subject to self-employment tax — that is the entire benefit. The comparison is a sole proprietor or single-member LLC paying 15.3% on all net earnings; an S corporation pays it only on the salary. Corporate formalities continue: minutes, share register, annual meeting. WHAT IT COSTS Election free. Payroll service USD 40-100 a month plus filings — unavoidable, because an S corporation with no payroll invites the IRS to recharacterise distributions as wages. Tax preparation 800-2,500 a year for Form 1120-S, K-1s and payroll returns. State franchise tax on S income where applicable (California: 1.5% of net income plus the USD 800 minimum). Plus the underlying entity's costs: 50-500 in state fees and 50-300 a year for a registered agent. Do the arithmetic first. If the extra payroll and accounting costs about USD 2,000 a year and you avoid 15.3% on distributions, the structure pays off at roughly USD 60,000-100,000 of profit above a reasonable salary. Below that it usually costs more than it saves — "get an S-corp" is bad advice on 40,000 of profit. IF YOU ARE NOT A US PERSON By statute, an S corporation may not have a non-resident alien as a shareholder, at any time, directly or indirectly. Nor may it have corporate or partnership shareholders, and only certain trusts and estates qualify. The moment an ineligible owner holds a share, the election ends. There is no workaround worth attempting. A US trust or a nominee US owner is exactly the arrangement the IRS looks for: the income is taxed to the true economic owner, the nominee carries personal exposure, and the entity risks losing the election retroactively. Nor would it help economically. The whole benefit is splitting earned income into a payroll salary and distributions free of self-employment tax, which only works if the owner is on the company's US payroll. A non-resident owner is generally not paying US self-employment tax on that basis anyway, so there is nothing to save. Use instead: a single-member LLC taxed as a disregarded entity if you have no US presence (remember the Form 5472 and pro forma Form 1120 filing, with a USD 25,000 penalty for missing it), or a Delaware C corporation if you have US employees or investors, where foreign ownership is straightforward and dividends are withheld at 30% or a reduced treaty rate once a W-8BEN or W-8BEN-E is on file. And the standing point: a company is not a work permit — E-2 for treaty nationals, L-1 for intra-company transfers, O-1 for extraordinary ability. For a US resident who works in the business, the S corporation remains the classic setup. For everyone else it is simply unavailable — one of the reasons US venture investors insist on C corporations. THE SHORT VERSION A pass-through tax election for an LLC or corporation, capped at 100 US individual shareholders with one class of stock: salary on payroll, distributions free of self-employment tax, and a threshold of roughly USD 60,000-100,000 of profit before the extra accounting is worth it. Foreigners are excluded by statute, with no legitimate way around it. General information, not legal or tax advice. Tax rules and thresholds change; confirm current figures with a licensed professional before electing or relying on this structure.