S Corp Income Tax: Everything You Need to Know
The S corp income tax refers to the income tax that the shareholders of an S corporation are required to pay. 3 min read
2. Additional Costs For S Corporations
3. Shareholders of an S Corporation
4. Active Shareholders vs Passive Shareholders
The S corp income tax refers to the income tax that the shareholders of an S corporation are required to pay. An S corporation is not directly subject to a federal income tax. The shareholders, on the other hand, pay income taxes based on the amount of income that they have been allotted by the S corporation.
C Corp Taxation Vs S Corp Taxation
"Double taxation" is a major topic of concern when it comes to subchapter C. If a C corporation earns an income that is taxable, the income is taxed twice. The income is subject to federal taxes at the corporate level. When the corporation distributes the income to the shareholders, the income is taxed again at the personal level.
On the other hand, S corporations are usually subject to only one level of taxation. When an S corporation generates income that is taxable, the income is generally not taxed at the corporate level. Instead, the income is distributed to the shareholders. The shareholders then pay taxes on the income on their personal income tax returns. Therefore, the income of an S corporation is not taxed a second time.
This is a major selling point for S corporations, which is why the business owners of many corporations opt to be taxed as S corps.
Additional Costs For S Corporations
Business owners enjoy savings with S corporations when it comes to self-employment taxes. However, an S corporation can be more trouble financially than it's worth. Just like with larger corporations, an S corporation will need to deal with start-up costs as well as accounting and legal costs, which are ongoing.
In certain states, S corporations are required to pay additional fees and taxes. For example, in the state of California, an S corporation needs to pay tax on 1.5 percent of its income. The minimum annual amount of taxes for an S corporation is $800. On the other hand, sole proprietors are not required to pay this tax.
Shareholders of an S Corporation
One hundred is the maximum number of shareholders that an S corporation can have. All shareholders of an S corporation need to be U.S. citizens. Also, a S corporation can't be owned by another business entity.
The owners of S corporations are subject to marginal tax rates that are similar to that of individual wages earners. However, the amount that an owner pays in taxes can depend on the owner's amount of participation in the business.
All S corporation owners need to pay the top marginal rate of 39.6 for federal individual income taxes. These owners also need to pay local and state income taxes, which range from 0 to 13.3 percent. These owners are also subject to the Pease limitation when it comes to itemized deductions. This adds a marginal tax rate of about 1.18 percent.
The payroll tax and the ACA Net Investment Income are responsible for differences in how different types of owners are taxed. The former is the tax that funds Medicare and Social Security, while the latter is an income tax that applies when income exceeds a certain threshold.
Active Shareholders vs Passive Shareholders
While an active shareholder plays a role in the daily activity of an S corporation, a passive shareholder does not play any role in the daily activity of the corporation.
Active shareholders usually receive the following two types of income from S corporations:
- Wage income
- Profit distribution
Active shareholders need to pay the payroll tax on the wage income. The payroll tax is 15.3 percent for the first $117,000 of income. For the next $83,000 of income, the payroll tax is 2.9 percent. For all income that exceeds $200,000, the payroll tax is 3.8 percent.
The profit distribution, on the other hand, is generally not subject to a payroll tax. Therefore, if an owner receives a total of $200,000 and 50 percent of the income is wage income, he will need to pay 15.3 percent in taxes on the $100,000 but will not need to pay any payroll tax on the other $100,000.
The top marginal tax rate for a shareholder who is active depends on whether the last dollar earned is wage or profit. Active shareholders can enjoy lower topical marginal tax rates than passive shareholders.
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