S Corp Self Employment Tax: Everything You Need to Know
The S corp self-employment tax refers to the self-employment taxes that the owners of S corporations are required to pay. 3 min read updated on September 19, 2022
The S corp self-employment tax refers to the self-employment taxes that the owners of S corporations are required to pay. Some business owners are interested in forming various types of business entities, such as S corporations, due to the possibility of reducing self-employment taxes. Here is everything you need to know about S corporation self-employment tax.
Pass-Through Tax Treatment Of S Corporations
For a corporation, the traditional tax structure consists of two taxation tiers:
- The corporate level
- The individual shareholder level
The business is an entity that is standalone and files a tax return. The business pays taxes on all of its income. Any income that has been accumulated by the corporation and distributed to the shareholders as dividends is taxed at the individual level on the tax returns of the shareholders.
However, the truth is that there are many small businesses that aren't considered separate entities. Rather, these businesses are sole proprietorships, and the business owners are taxed for the income of the businesses on their personal tax returns.
Many partnerships are simply a combination of multiple sole proprietorships. Accordingly, it would be unnecessarily complex to apply a two-tier tax structure for corporate entities to a partnership. It would also not be very representative of the reality of the matter, which is that the business simply consists of two people joining forces to create a joint venture.
In order to accommodate these types of businesses, the tax code states that partnerships can be taxed like pass-through entities. A pass-through entity has its income taxed at the individual level, rather than the business level. The income is passed to the partners, and the amount passed to each partner depends on the relative shares. This avoids the two-tier double taxation that typically applies to corporate income.
A major challenge that many businesses run into is that they don't want their business to be structured as partnerships. In some cases, LLCs don't want to be taxed like partnerships. Sometimes, the reason is due to liability exposure that can impact the partners, while other times, there exists a desire to make it simpler to transfer the business, particularly in small pieces for the purpose of success planning.
The tax code permits corporations to elect the S Subchapter. By making the S election, the corporation is choosing to be treated, for the purposes of federal taxes, as an S corporation. When a corporation makes an S election, the business is considered a C corporation for legal purposes but is taxed like a pass-through entity. An S corporation needs to meet all the normal legal requirements to establish and maintain the corporation. However, the S corporation is treated similarly to a partnership when it comes to taxes.
The S election permits businesses to enjoy limited liability, transferability, and the other advantages associated with a corporation. However, the business still enjoys the pass-through treatment, which enables the business to avoid two-tier taxation.
An LLC is able to choose to be taxed like a partnership or like a corporation under the rules referred to as "Check the Box." Choosing to be taxed as a corporation involves making the S election.
The tax code has limitations regarding the types of corporations that are allowed to make S elections. The purpose of these limitations is to prevent abuse potential. The number of shareholders that a corporation can have to qualify for S election must be 100 or fewer. Most trusts are not permitted to own S corporations. Also, an S corporation is only allowed to have one stock class. However, there can be non-voting and voting shares.
Besides these restrictions, the S corporation is an appealing choice for many small business owners who want to enjoy the structure of a corporation along with the tax treatment of a partnership. In the eyes of many small business owners, the S corporation is a good compromise between a C corporation and a partnership.
S Corporation Dividends And FICA Self-Employment Taxes
S corporations are taxed like partnerships in that an S corporation is viewed as a pass-through entity. However, the rules for self-employment taxes for S corporations and the rules for self-employment taxes for partnerships are not the same.
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