How S Corporations are Taxed: Everything You Need to Know
Knowing how S corporations are taxed can help you decide if it's beneficial for you to choose this tax designation for your business. One of the advantages of S corps is pass-through taxation, as well as the possibility of paying less in self-employment taxes.3 min read
2. How Are S Corporations Taxed?
3. Avoiding Double Taxation
4. Simplified Tax Filing
5. Can an S Corp Reduce Self-Employment Taxes?
Knowing how S corporations are taxed can help you decide if it's beneficial for you to choose this tax designation for your business. One of the advantages of S corps is pass-through taxation, as well as the possibility of paying less in self-employment taxes.
About S Corporations
S corps are corporations that choose to pass the following through to company shareholders for tax purposes:
- Corporate income
An S corp's shareholders report income and losses on their personal tax returns. Their taxes are assessed at individual rates. This pass-through taxation means that shareholders aren't taxed twice, or what's commonly known as double taxation. They don't have to pay individual and corporate taxes.
These business types pay taxes on certain passive income and built-in gains. If an S corp donates to charity, this charitable contribution is reported on the Schedule K-1. Plus, the shareholder reports his or her portion as an itemized deduction.
How Are S Corporations Taxed?
Business owners may elect for S corp designation for these two important benefits:
- The elimination of double taxation
- Simplified tax filing
Avoiding Double Taxation
In a C corp, proceeds are basically taxed twice. Individual shareholders are taxed on capital gains and dividends, and the company is taxed on the corporate level. If a shareholder is also a corporation's primary owner, he or she is taxed twice.
In S corps, however, the net income of the company goes straight to the shareholders and owners. They in turn pay taxes on it via their individual tax returns. Corporate tax rates are usually higher than personal tax rates, so an S corp owner will probably pay less taxes. The tax difference between C corps and S corps doesn't lie in how much income is taxed, but where and when it's taxed.
Simplified Tax Filing
The way S corps file taxes is simpler than how C corps file them. There's no need for a separate corporate tax return, for one thing. You'll probably have to file some additional forms, and you will have to report proceeds separately. For instance, S corp proceeds aren't the same as C corp dividends. However, these added steps should take much less time than having to prepare a separate corporate tax return.
In addition, while you might have to pay payroll taxes more frequently if you employ people, in an S corp, you only have to file taxes once a year. C corps must file every quarter.
If you don't earn a regular paycheck or you don't have sufficient funds withheld from your pay, you'll likely be required to pay estimated taxes every quarter. This is still simpler than filing a full corporate tax return every quarter.
Can an S Corp Reduce Self-Employment Taxes?
Anyone who's an active shareholder in an S corp receives two types of income: wages and profit distribution.
Because many businesses would naturally want to distribute as much profit as possible while keeping wages low, the IRS puts guidelines in place so that businesses pay a reasonable salary to their active owners.
Everyone — employee of a company or self-employed individual — must pay various taxes to the government, including Medicare and Social Security taxes. If you're employed by someone else, you only pick up a portion of these taxes and your employer pays the rest. Self-employed individuals are responsible for both portions of these taxes.
If you elect to operate as an S corporation, you'll be able to classify your income differently. Some of it will be your salary and some will be distribution. You'll have to pay self-employment tax on the salary portion, but for the distribution portion, you'll only pay regular income tax. You might be able to save a substantial amount of money on self-employment tax, depending on how you classify your income, just by electing the S corp tax designation.
On the surface, S corps seem to have many benefits, especially in terms of taxation. However, that's not the only reason to elect for S corp designation. Being familiar with all the specific details of this business type is the best way to make the right decision for your company.
If you need help understanding taxes for S corps or other businesses, 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.