Key Takeaways

  • An S Corp generally does not pay federal income tax; income passes through to shareholders’ personal tax returns.
  • S Corps file IRS Form 1120S, and shareholders receive Schedule K-1 to report their share.
  • Shareholders must pay reasonable compensation to avoid IRS scrutiny.
  • S Corps are responsible for payroll taxes, unemployment taxes, and possibly state-level taxes.
  • Importantly, your S Corp cannot pay your personal tax bills directly without triggering tax and accounting issues.

Does an S Corp Pay Taxes

Does an S Corp pay taxes is a common question for business owners who want to incorporate their business and further elect to be taxed as an S Corp. An S Corp is taxed differently from C Corporations, as the S Corp avoids double-taxation. The S Corp doesn’t pay corporate income tax. Instead, the business passes through its profits to the shareholders who must report a portion of the profits on their personal tax return (Form 1040). Keep in mind that the S Corp can have only 100 shareholders at most, all of who must be U.S. citizens; the shareholders cannot be businesses.

How the S Corp Pays Taxes

As previously mentioned, the S Corp passes its profits, losses, credits, and deductions to its shareholders who report it on their personal tax returns. Therefore, the S Corp doesn’t pay federal income taxes. However, this is really the only difference between the S and C Corp.

While the S Corp doesn’t pay corporate tax, it still must file IRS Form 1120S, which will include the share of profits and losses for each shareholder. Thereafter, the information will be identified on Schedule K-1 for each shareholder. This form will then be given to the shareholder so that he or she knows what to report on their tax return (Form 1040- Line 17).

How Owners Are Taxed

The owners of the S Corp will be taxed based on their percentage of ownership in shares. For example, if the S Corp has profits of $500,000 and there are 4 shareholders, then each shareholder will pay $100,000 in profits. Generally, all shareholders must pay two types of income – wage income and a profit distribution.

The wage income is subject to payroll tax. Any shareholder/employee of the S Corp must be paid a reasonable compensation, which is determined by considering several factors that most courts look at when deciding if the salary is sufficient.

The profit distribution is not taxed. This means that the dividends are paid out tax-free. Because of this, shareholder/employees would rather be paid in dividends and not wages, so to reduce their tax liability.

Since there is a large incentive to pay higher dividends and less compensation, the IRS closely monitors how much compensation each shareholder/employee pays him or herself. Also, keep in mind that the IRS could subsequently determine that you are not paying yourself a reasonable salary and therefore, re-allocate your dividends into wages making you pay taxes on it.

You will have to pay Social Security and Medicare taxes on the compensation you earn from the S Corp. However, a benefit of the S Corp is the fact that you don’t have to pay self-employment taxes on the wages you earn from the business or the dividends paid out.

Determining Reasonable Compensation

In order to determine what constitutes a reasonable salary, there are several factors that should be taken into account, including the following:

• The type of work conducted by the shareholder/employee

• The level of education

• Number of years of professional experience

• Amount of time dedicated to working for the S Corp

• Amount of dividends that the shareholder/employee receives from the business

• What other non-shareholder employees make for similar services

• What other professionals make for other businesses in the same industry

Other Taxes

The S Corp will likely pay other types of taxes, including withholding taxes, employment taxes on wages paid to employees, paying FICA taxes for the Social Security and Medicare taxes that will be jointly paid by you and the employee, workers compensation taxes, and unemployment taxes. If the S Corp owns property, then the company will need to pay property taxes.

Furthermore, the S Corp might also need to pay state sales tax and excise tax. Some states charge state income taxes, franchise taxes, gross receipt taxes, and other state-related fees depending on the industry in which you operate. Be sure to visit your State’s Secretary of State website to determine what state and local fees are due for your business.

State-Level Tax Obligations

In addition to federal taxes, some states impose their own taxes on S Corps or require S Corps to pay franchise taxes, excise taxes, or state-level income taxes. For example:

  • California charges an annual franchise tax on S Corps, even though the entity avoids federal corporate income tax.
  • New York has a state-level S Corp filing requirement with specific taxes on S Corp income.
  • Some states may also have gross receipts taxes or require annual reports with filing fees.

Always check your state’s rules to ensure you meet all local compliance requirements, as state tax rules can vary significantly and may affect both the corporation and its shareholders.

Can My S Corp Pay My Personal Taxes?

While an S Corp offers pass-through taxation benefits, it’s critical to understand that the business and its shareholders are separate tax entities. This means that although the corporation’s profits pass through to your personal tax return, the S Corp itself cannot pay your personal tax bills directly. Doing so could be considered a constructive dividend or a shareholder distribution, which can lead to unintended tax consequences.

Here’s why:

  • Personal tax obligations are the shareholder’s responsibility, not the corporation’s.
  • If the S Corp pays your personal taxes, the IRS may reclassify these payments as additional income to you, possibly resulting in additional taxes, penalties, or interest.
  • Proper distributions must follow corporate formalities and be reported accurately on Schedule K-1.
  • Even though profits flow through to you, personal tax payments should come from your personal funds (after receiving distributions or salary) — not directly from the company’s accounts.

To stay compliant:

  • Pay yourself a reasonable salary through payroll.
  • Take official shareholder distributions following the rules.
  • Use those personal funds to pay personal taxes.

If you’re unsure how to handle S Corp distributions or tax payments, consider consulting a qualified tax professional or attorney. You can find experienced attorneys on UpCounsel to help navigate these issues and avoid costly mistakes.

Frequently Asked Questions

  1. Can my S Corp pay my personal tax bills directly?
    No. The S Corp should not pay your personal tax liabilities directly. Any payment made would generally be treated as income or a dividend to you and could trigger additional taxes.
  2. How does an S Corp help reduce my personal tax burden?
    An S Corp allows you to avoid self-employment taxes on distributions and only pay payroll taxes on your salary, potentially reducing your overall tax liability if structured properly.
  3. What forms does an S Corp need to file with the IRS?
    The S Corp files IRS Form 1120S annually and provides each shareholder with a Schedule K-1 detailing their share of income, deductions, and credits.
  4. Do S Corp shareholders pay estimated taxes?
    Yes. Since S Corps pass income through to shareholders, shareholders are generally responsible for making quarterly estimated tax payments to cover their individual tax obligations.
  5. What happens if I don’t pay myself a reasonable salary?
    The IRS may reclassify distributions as wages, leading to penalties and additional payroll taxes. It’s essential to pay yourself a fair market salary for the work you perform.

If you need help learning more about S Corporation taxes, or if you need assistance filing state or federal taxes for your S Corp, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5-percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law, and average 14 years of legal experience, including work with, or on behalf of companies like Google, Menlo Ventures, and Airbnb.