An S-corp isn’t a kind of business. It’s a tax election. You form an LLC or a regular corporation, and then you tell the IRS “tax me as an S-corp.” The election trades self-employment tax on a portion of profits for a salary-and-distribution structure. Done right, it saves real money. Done wrong, or terminated by accident, it can cost more than it saved.
Who qualifies
- Domestic entity (US-organized LLC or corporation)
- No more than 100 shareholders (family members count as one)
- Only individuals, certain trusts, and certain estates as shareholders (no partnerships, no most LLCs, no non-resident aliens)
- Only one class of stock (different voting rights are OK; different economic rights are not)
How to revoke (when you want out)
Revocation requires consent from shareholders owning more than 50% of stock and a written statement filed with the IRS. Timing matters: file by the 15th day of the third month of a tax year to revoke for that year; later than that, the revocation kicks in the following year. You can also pick a specific future effective date.
Once revoked, the entity is taxed as a C corporation (or back to a default LLC pass-through, depending on what it was). You can’t re-elect S status for 5 years without IRS consent.
What can terminate the election by accident
This is the trap. The S-corp election terminates automatically the day you fail one of the eligibility rules. The most common triggers:
- A shareholder transfers stock to an ineligible holder (a foreign person, a non-grantor trust that isn’t qualifying, an LLC)
- The 100-shareholder limit is exceeded
- You create a second class of stock by mistake (often via disproportionate distributions or non-pro-rata loan terms)
- Foreign income / passive income exceeds 25% of gross receipts for three consecutive years (only if the corp has accumulated C-corp earnings)
The cure: inadvertent termination relief
If you discover an accidental termination, the IRS has a cure under § 1362(f). You file for relief, show it was inadvertent, correct the issue, and the election is treated as if it never terminated. This relief is common and usually granted, but it requires a private letter ruling and the filing fees (currently around $12,000).
The bottom line
The election itself is a one-page form. The harder part is keeping the election in good standing year over year. Shareholder changes, distribution mechanics, stock transfers, all need to be done with the S-corp rules in mind, or you risk an accidental termination that costs more to fix than the original tax savings.