S Corporation Taxes and Form 1120-S

An S corporation is a tax status, not a type of business you form with the state. A corporation, or an LLC taxed as a corporation, can elect it. Once the IRS accepts the election, the business generally pays no federal income tax itself. Profits and losses pass through to the owners' personal returns. This guide covers who qualifies, how to elect, forms, deadlines and Illinois rules.

How an S corporation is taxed

The company reports its income on Form 1120-S and gives each shareholder a Schedule K-1 showing that person's share of income, deductions and credits. Shareholders report those amounts on Form 1040, usually on Schedule E, and pay tax at individual rates.

You are taxed on your share of profit, not the cash you take out. Profit left in the business is still taxable to you and raises your stock basis.

Example: A calendar-year S corporation with two equal owners earns $120,000 in 2025 and distributes $40,000 to each. Each owner gets a K-1 showing $60,000 and reports all of it, although only $40,000 came out in cash. The other $20,000 per owner increases basis.

S status does not remove payroll tax, because owners who work in the business are employees. See reasonable compensation for S corporation owners and payroll for S corporation owners.

Who can be an S corporation

The business must:

• Be a domestic corporation, or a domestic LLC or similar entity eligible to be taxed as one
• Have no more than 100 shareholders (certain family members count as one)
• Have only individuals, estates, certain exempt organizations and certain trusts as shareholders, and no nonresident aliens
• Have one class of stock, although voting rights may differ
• Not be an ineligible type, such as certain banks or insurance companies

Check ownership first. A partnership, a corporation or a nonresident alien cannot be a shareholder, which matters with relatives or investors abroad (see Indian business ownership forms). Unequal rights to profits can create a second class of stock, so ask an attorney to review shareholder agreements.

How to make the election

File Form 2553, signed by an officer, with the required shareholder consents. A calendar-year corporation that wants S status for 2027 can file any time in 2026 or by March 15, 2027. An LLC need not file Form 8832 first, because a timely Form 2553 also counts as an election to be taxed as a corporation. See LLC tax classification.

If you missed the deadline, Rev. Proc. 2013-30 may give relief when you file within 3 years and 75 days of the intended start date, have reasonable cause and everyone reported income consistently with S status. Otherwise a private letter ruling is generally needed.

The election ends automatically if the company stops meeting the rules. A new election then generally needs IRS consent until the fifth tax year after the termination year.

Forms, deadlines and penalties

• Schedule K-1 goes to every shareholder. Schedules K-2 and K-3 are needed only for international items, and several exceptions exist.
• Form 7203 tracks stock and debt basis. Shareholders file it when they claim a loss, receive a non-dividend distribution, dispose of stock or receive a loan repayment.

A late or incomplete return costs $255 per shareholder for each month or part of a month, up to 12 months, on returns due in 2026 (tax year 2025). Not giving shareholders correct K-1s can cost $340 per schedule for tax year 2025. Reasonable cause can excuse them. See the S corporation late-filing penalty.

Basis, distributions and losses

Basis starts with what you paid or contributed, rises with income and falls with losses, nondeductible expenses and distributions, never below zero. Distributions up to basis are tax-free. Amounts above basis are taxed as capital gain.

Losses are limited to your stock basis plus loans you personally made to the company. Guaranteeing a bank loan does not add basis. At-risk, passive activity and excess business loss limits then apply. Unused losses carry forward.

Taxes the company itself can owe

A former C corporation that sells appreciated assets within five years after its S election can owe built-in gains tax at the highest corporate rate (21%). A company with leftover C corporation earnings and more than 25% passive income can owe excess net passive income tax, and three straight years of that ends the election.

Illinois notes

An Illinois S corporation pays 1.5% personal property replacement tax on net income but no Illinois income tax at the entity level. Shareholders pay Illinois income tax at a flat 4.95%. Form IL-1120-ST is due the 15th day of the 3rd month after year-end, with an automatic seven-month extension to file (tax is still due on the original date).

Illinois also offers an elective pass-through entity (PTE) tax of 4.95% of net income, paid by the company with a matching credit to shareholders. It lets the entity deduct state tax on the federal return, which can ease the individual cap on state and local tax deductions. Electing companies expecting more than $500 of tax make estimated payments. Illinois has removed the election's expiration date. Without it, the company makes pass-through withholding payments for nonresident shareholders.

Common mistakes

• Filing Form 2553 late or without every consent
• Taking distributions but no wages
• Admitting an ineligible shareholder, such as a trust without the right election
• Deducting losses without tracking basis

How we can help

We can test whether S status fits your numbers, prepare Form 2553 and Form 1120-S, set up owner payroll and keep basis schedules. See our business tax preparation, payroll services and business formation pages, or compare options in LLC, S corporation or C corporation.

Frequently asked questions

General information only, not tax, legal or accounting advice for your situation. Rules, limits and deadlines change; confirm the current rules with the official source or a qualified professional before you act. Reading this page does not create a professional relationship with CPA Tax Payroll and Accounting Corp.