S Corporations and State Considerations: Where to Form, Where to File

An S corporation is a domestic corporation that elects pass‑through treatment under Subchapter S: it remains a corporation under state law, but its income, losses, deductions, and credits generally flow through to its eligible shareholders for federal tax purposes. To qualify, the corporation must meet the “small business corporation” requirements (e.g., domestic, no more than 100 shareholders, only allowable shareholders, one class of stock) and file a valid election; the election continues until revoked or terminated under the statute and regulations. See Internal Revenue Code (IRC) §§ 1361–1362 (U.S. Code) and Treasury Regulations at 26 C.F.R. §§ 1.1361‑1, 1.1362‑1 (eCFR), and the IRS’s S Corporations page (IRS).

Because an S corporation is a pass‑through, the “best” or “worst” state to have one is rarely about the state’s corporate income tax rate (many states don’t impose corporate‑level income tax on qualifying S corps). Instead, practical differences across states arise from:

• The owner’s personal income tax in their resident state on pass‑through income.

• State‑level entity/franchise/de minimis taxes and fees that apply regardless of pass‑through status.

• Where the business has nexus (economically or physically) and must register and file (formation state vs. operating states).

• Administrative requirements (annual reports, e‑filing thresholds, etc.).

Federal rules apply uniformly; state outcomes depend on where you actually do business and where your shareholders reside.

Key Federal Rules and State Interactions

• Eligibility and election. The corporation must meet Subchapter S eligibility and file Form 2553; the election takes effect and continues until revoked or terminated under § 1362 (e.g., by becoming ineligible, or due to passive investment income and accumulated earnings and profits). See IRC § 1362 IRC § 1362 (U.S. Code), IRS S Corporations page (IRS), and 2024 Instructions for Form 1120‑S (IRS).

• Pass‑through taxation. S corporation items flow to shareholders; shareholders report them on their individual returns (and states tax them under their rules). The corporation files Form 1120‑S; shareholders receive Schedule K‑1. See IRS S Corporations page (IRS) and 2024 Instructions for Form 1120‑S (IRS).

• Formation and EIN. You form the entity under a state’s corporate statute, then obtain an EIN. The IRS advises forming through your state before applying for an EIN. See Get an EIN (IRS).

• Where you must register/file (nexus). States can require registration and filing based on “economic nexus,” even without physical presence. The Supreme Court’s decision in South Dakota v. Wayfair, Inc. held that states may impose collection and filing obligations on remote sellers based on substantial economic contacts (overruling the strict physical‑presence rule). See Wayfair (U.S. Supreme Court). For income taxes, the Multistate Tax Commission’s revised statement on Public Law 86‑272 explains that the federal protection for mere solicitation of tangible goods is narrow; most services/internet activities are not protected, and modern “virtual” contacts can count toward in‑state business activity. See MTC Statement on P.L. 86‑272 (Multistate Tax Commission).

Does the S Corporation Need to Be in the Owner’s State?
No—federally, the S corporation can be formed in any state. But two practical rules apply:

• You must “foreign qualify” wherever you actually do business. If you form in State A but operate (have employees, customers, property, or economic nexus) in State B, you’ll need to register in State B as a foreign corporation and comply with State B’s filing, tax, and regulatory rules. Wayfair confirms that economic activity (not just physical presence) can create obligations. See Wayfair (U.S. Supreme Court). Public Law 86‑272 does not protect service or internet activities, and only narrowly protects solicitation of tangible goods, so most businesses will have state tax filing duties where they operate. See MTC Statement on P.L. 86‑272 (MTC).

• Your resident state will tax your pass‑through income. Even if the corporation is formed in a no‑income‑tax state, shareholders generally owe personal income tax on their S corporation distributive share in their state of residence, because S corporation income flows through to the individual’s return. See IRS S Corporations page (IRS).

Therefore, forming outside your home state seldom avoids your resident state’s individual taxation of your share of S corporation income. If you operate in multiple states, you may have filing obligations and apportionment in those states as well (and your resident state typically taxes you on all income with a credit for taxes paid to other states, subject to its rules).

Factors That Make a State “Better” or “Worse” for an S Corporation

• Owner‑resident personal income tax. Because S corp income is taxed to shareholders, the owner’s resident state personal tax is usually the dominant lever on total burden—even if the corporation is formed elsewhere. See IRS S Corporations page (IRS).

• Entity/franchise taxes and fees. Some states impose minimum franchise taxes, annual fees, or gross receipts taxes on corporations regardless of pass‑through status. These can be material to entity‑level costs and can apply in the state(s) where you operate.

• Nexus footprint. After Wayfair, economic activity can create filing obligations across states (e.g., remote services, online sales), and P.L. 86‑272 protection is limited to solicitation of tangible goods. Service/consulting and internet‑based businesses may have filing obligations in many states even without offices. See Wayfair (U.S. Supreme Court); MTC Statement on P.L. 86‑272 (MTC).

• Administrative burdens. Annual reports, e‑file thresholds, and penalties can differ. For example, for returns due on or after January 1, 2024, corporations that file 10 or more returns during the calendar year are generally required to e‑file Form 1120‑S. See 2024 Instructions for Form 1120‑S (IRS).

• Formation/foreign‑qualification costs. The IRS emphasizes forming the entity under state law before obtaining an EIN; if you form in one state and operate in another, expect foreign‑qualification costs in the operating states. See Get an EIN (IRS).

Practical Guidance

• If you operate in your home state, forming there often simplifies compliance. You avoid a dual regime (formation state + operating state), foreign qualification, and duplicative annual filings—without changing federal tax results. See Get an EIN (IRS).

• If you operate in multiple states (or remotely), assume economic nexus drives registration and filing where customers are. Plan for remote seller/service obligations post‑Wayfair and recognize that P.L. 86‑272 protection is narrow and does not cover service/internet activities. See Wayfair (U.S. Supreme Court); MTC Statement on P.L. 86‑272 (MTC).

• Do not expect incorporation in a no‑tax state to eliminate your personal tax on pass‑through income. Your resident state generally taxes your distributive share from the S corporation. See IRS S Corporations page (IRS).

• Mind eligibility and election continuity. Ensure shareholder eligibility, one class of stock, and watch passive investment income limitations; losing eligibility can terminate S status with significant tax consequences. See IRC §§ 1361–1362 (U.S. Code) and 2024 Instructions for Form 1120‑S (IRS).

• File and e‑file as required. S corporations generally use Form 1120‑S and shareholders receive Schedule K‑1. E‑file thresholds apply to many filers beginning with returns due on or after January 1, 2024. See 2024 Instructions for Form 1120‑S (IRS).

Bottom Line

• “Best” and “worst” states for an S corporation depend primarily on (i) where you actually do business (nexus) and (ii) where your shareholders reside—because S corporation income is taxed at the shareholder level. Incorporation in a different state does not, by itself, change those facts. See IRS S Corporations page (IRS).

• You do not have to form the S corporation in the owner’s resident state; however, you must register and file in any state where you do business, and your home state will generally tax your pass‑through income. Form where it makes administrative sense, but plan for foreign qualification and multi‑state filings driven by economic nexus post‑Wayfair. See Get an EIN (IRS); Wayfair (U.S. Supreme Court); MTC Statement on P.L. 86‑272 (MTC).

• Always maintain Subchapter S eligibility and comply with federal filing/e‑file requirements; S elections are fragile and terminations can be costly. See IRC §§ 1361–1362 (U.S. Code) and 2024 Instructions for Form 1120‑S (IRS).

This essay is not tax advice. Always consult a qualified tax professional for your specific situation.