How is an S corporation taxed?

An S corporation is taxed as though it were a partnership, which means that the income, deductions, credits, and losses of the corporation are passed through to the individual shareholders and reported on their personal tax returns. This allows for the avoidance of double taxation, which often occurs in C corporations where the business income is taxed at the corporate level and again at the individual level when distributed as dividends.

Additionally, S corporations have specific restrictions on who can be shareholders and the number of shareholders, which must comply with IRS regulations. This is distinct from a traditional partnership, where the ownership can be more flexible without limitations on the number of partners. The pass-through taxation benefit is a significant incentive for small businesses that aim to be treated as corporations while enjoying the tax efficiencies similar to partnerships.