S-Corporations Taxes

S Corporation

A domestic corporation (including an LLC that has elected corporate status) with no more than 100 shareholders and that meets certain other requirements can choose to be taxed as an S Corporation by filing Form 2553, Election Statement by a Small Business. An S Corporation has some of the properties of both C Corporations and partnerships.

Keep in mind, also, that an S and C Corporation are for a federal election – at the state level, if you choose either structure, you’re simply seen as a corporation.

Similar to a partnership, the corporation reports all income, deductions, etc., on the entity return, but passes them through to the shareholders via Schedule K-1 (Form 1120-S). Each shareholder’s share of these items is strictly based on the shareholder’s percentage ownership of the company. For instance, a shareholder who owns 75% of the company would receive 75% of net income, credits, etc.

Owners pay taxes on their distributive shares of corporate profits and on their salaries at their appropriate individual rates. Shareholders are required to pay themselves a “reasonable wage” and pay the employee’s share of Social Security taxes on their wages.

Advantages of S corporations:

Many small business owners favor the S corporation structure because of its tax benefits. This type of business entity has the same legal protections as a C Corporation. Unlike C corporations, after-tax profits distributed to shareholders aren’t generally taxed again as dividends at the individual level. So, S corporation owners avoid double taxation.

Like sole proprietors and partners, S Corporation shareholders are potentially eligible for the qualified business income deduction. Shareholders are also eligible to claim the self-employed health insurance deduction.

Drawbacks of S corporations:

Like a C Corporation, an S corporation must be incorporated at the state level, which can also be difficult and expensive.

The entity should elect S corporation status at the federal level at the beginning of its first year.

Also, like C corporations, S corporations must follow certain administrative procedures, such as scheduling specific meetings, keeping records, and maintaining bylaws.

Because shareholders pay FICA and Medicare taxes on their salaries (rather than self-employment tax), they are subject to IRS scrutiny regarding what constitutes “reasonable compensation.”