S Corp Master Guide

S Corporation Taxation 2025

A technical deep dive into the mechanics of Subchapter S: Pass-through architecture, Basis ordering rules, and the compliance traps of Form 7203.

Executive Summary

The S Corporation is a tax status, not a legal entity. Whether formed as an LLC or a Corporation, the S election (Form 2553) transforms the business into a "Conduit." Income flows through to shareholders via Schedule K-1, avoiding the double taxation of C Corps.

However, this benefit relies on a rigid infrastructure. Shareholder Basis is the operational "Third Rail"—it limits loss deductions and determines if distributions are tax-free. Miscalculating basis on the new Form 7203 is a primary audit trigger in 2025.

The Conduit

No Entity Tax: Profits flow to owners. Losses flow too, but are only deductible if you have Basis.

The Order

Basis Hierarchy: Income adds first. Distributions subtract second. Losses subtract last. This order matters.

The Limits

Strict Eligibility: 100 Shareholders max. One Class of Stock only (no preferred economic rights).

The "One Class" Trap

Disproportionate Distributions

The "One Class of Stock" rule means every share must have equal economic rights. If you distribute cash to one owner but not another (disproportionate), you may inadvertently terminate your S Election.

Permissible Differences

Voting Rights

You CAN have Voting and Non-Voting common stock. This is useful for keeping control while giving equity to employees.

Economic Rights

You CANNOT have Preferred Stock or different dividend rights. All profits must be allocated strictly pro-rata.

The Basis Ladder (Section 1367)

Basis is not static. It breathes. You must adjust it annually in a specific sequence to determine taxability.
1

Increase: Income

Add all income items (including Tax-Exempt income like PPP forgiveness or Muni bond interest).

2

Decrease: Distributions

Subtract cash taken out.
Critical: Distributions reduce basis before losses are checked.

3

Decrease: Losses

Subtract losses/deductions. If basis hits zero, stop. Remaining losses are Suspended.

State Mechanics: The WA Anomaly

While S Corps are "pass-through" federally, states like Washington treat them differently.

B&O Tax (Gross Receipts)

Washington ignores net income. It taxes Gross Receipts.

Trap: Paying officer salary reduces Federal Income, but does NOT reduce WA B&O taxable base.

Capital Gains Excise Tax

A 7% tax on long-term capital gains over $262k (adjusted).

Impact: Gains from selling S Corp stock or assets flow through to the WA resident owner and are subject to this tax.

Interactive: Shareholder Basis Sequencer

Input your annual figures to see how the "Ordering Rules" affect your ending basis, taxable distributions, and suspended losses.

Annual Activity

Includes Tax-Exempt Income.

Sequence Results

1. Basis after Income $0
2. Basis after Distributions $0
3. Ending Basis (After Losses) $0
Taxable Distribution
$0
Capital Gain
Suspended Loss
$0
Carry Forward