Key Takeaways

  • S corporations are pass-through entities for tax purposes, avoiding corporate income tax.
  • S corp owners must pay themselves a reasonable salary subject to FICA and FUTA taxes.
  • Shareholders not receiving wages are generally exempt from unemployment taxes.
  • States may have additional requirements, including unemployment insurance and workers' compensation taxes.
  • Whether S corp owners have to pay unemployment tax depends on if they are classified as employees

The taxation of S corps is based on the pass-through principle. Taxes on S corps include FICA taxes at a rate of 15.3 percent of each employee's wages and Federal Unemployment Taxes at a rate of about 6 percent of wages. An S corp shareholder must also pay taxes on his or her earnings to the tune of 10-37 percent. Some high-earning inactive shareholders may also qualify for the Net Investment Income tax.

States also levy a number of taxes, and these may include franchise tax, sales tax, unemployment tax, workers compensation taxes, and more. Some states also tax the personal income of S corp shareholders. The outstanding tax difference between S corps and C corps is that the IRS does not levy corporate income tax on the S corporation.

The Rationale Behind S Corp Taxation

The S corp business type is an entity type that was launched to reduce the tax burden on small corporations. This corporation taxation type gets its name from Subchapter S of the Internal Revenue Code, which regulates these types of corporations. Small businesses that choose to get S corporation treatment communicate their decision to the IRS using Form 2553. Such businesses are required to meet a number of requirements, including the following:

  • The corporation must have a maximum of 100 shareholders.
  • The corporation should not have non-U.S. citizen shareholders unless they reside in the U.S.
  • The corporation should have only one type of stock.
  • The decision to file as an S corporation must be unanimous.

Despite the fact that S corporations are not required to pay corporate tax, the corporation must still pay most of the other taxes that traditional corporations pay.

Taxes That S Corporations Pay

  • Medicare and Social Security (FICA) Taxes. S corps that have employees must withhold and pay Medicare and Social Security taxes. The corporations also add their contribution to each employee's tax and pay a total of about 15.3 percent of the employee's wages. These taxes must be paid by employee-shareholders of the S corp.
  • Federal Unemployment (FUTA) Tax. The federal unemployment tax is paid by most S corporations that have permanent employees. It is charged at a rate of about 6 percent of the wages paid to the employees.
  • Excess Net Passive Investment Tax. The IRS does not want businesses whose income comes from predominantly passive means to file as S corporations. While S corporations that get their incomes actively do not pay corporate tax, S corporations which earn more than 25 percent of their gross receipts from passive ventures must pay corporate tax on the passive income beyond the 25 percent threshold. Income from passive means includes all income from investment or rental properties.

Do S Corp Owners Have to Pay Unemployment Tax?

Whether S corporation owners must pay unemployment tax depends on their classification and role within the company. The key consideration is whether the owner actively works for the S corp as an employee.

S corp owners who perform substantial services for the business and receive compensation are considered employees. In these cases:

  • Federal Unemployment Tax (FUTA) applies to the wages paid to the owner-employee. The FUTA rate is generally 6.0%, though it may be offset by credits for state unemployment tax payments.
  • State Unemployment Tax (SUTA) may also apply, and rates vary by state. Some states exempt owner-officers under certain conditions, while others require tax contributions regardless of ownership percentage.

However, if an S corp shareholder does not perform services for the business and is not receiving wages (only distributions), they are typically not subject to unemployment tax, because the IRS and most states do not consider them employees.

S corp shareholders are not allowed to avoid employment taxes by taking only distributions. The IRS requires that any shareholder who provides services must receive a reasonable salary, which is subject to employment taxes, including unemployment tax.

Some states (e.g., Florida) impose strict guidelines on how compensation is reported, and failure to comply can trigger audits or penalties.

Taxation of S Corporation Shareholders

  • Federal Income Tax. S corporation shareholders must pay income tax on their share of the corporation's earnings. This tax is paid at rates that range from 10 to 37 percent of the income and is due even if the earnings are not distributed to the shareholders.
  • Net Investment Income Tax. The net investment income tax, which launched in 2013, is levied on high-earning S corp shareholders who are not employees of their S corporations. To be eligible for this tax, the shareholder must earn over $200,000 from the S corp in a year. Couples that file jointly must earn over $250,000 to qualify for this tax. It is charged at a rate of 3.8 percent of the income beyond the threshold.
  • State Income Tax. Some states require S corp shareholders to pay income tax. The rate for this tax differs from state to state.
  • State Franchise Tax. Most states require S corporations to pay franchise tax. The rates depend on the state and on the income of the S corporation.
  • State Sales Tax. S corporations that are involved in selling goods or services are normally required to pay sales tax to the state. The rates vary from state to state.
  • Excise Tax. Some S corporations that are involved in manufacturing are required to pay state excise tax.
  • Unemployment and Workers' Compensation Insurance. Many states require S corporations in their states to pay taxes to state workers' compensation funds and unemployment funds.

State-Specific Rules for S Corp Owner Taxes

Each state enforces its own approach to taxing S corporations and their owners. In addition to general state income tax obligations, S corp owners may be subject to:

  • Unemployment Insurance Taxes (SUTA): Required if the owner is classified as an employee. For example, in Florida, failure to report a reasonable wage for an S corp owner can lead to tax assessments and penalties.
  • Workers' Compensation: Some states mandate coverage even for owner-employees, especially if the S corp has multiple employees.
  • Franchise or Privilege Taxes: These taxes apply to the business entity regardless of its federal tax classification. States like Texas and California have their own versions of these taxes.
  • Minimum Tax Payments: In some jurisdictions, even zero-income S corps may owe a minimum annual tax (e.g., California’s $800 minimum franchise tax).

Given the variety in state law, S corp owners should check with their state’s revenue department or consult a tax professional to ensure compliance.

Frequently Asked Questions

1. Do S corp owners have to pay unemployment tax?

If an S corp owner performs services and receives wages, they are classified as employees and must pay unemployment tax. Passive shareholders do not pay this tax.

2. How much is the FUTA tax for S corporations?

The standard FUTA tax rate is 6.0% on the first $7,000 of each employee’s wages. Many employers receive a credit of up to 5.4% for paying state unemployment taxes.

3. Can an S corp shareholder avoid paying unemployment tax?

Yes, if the shareholder does not perform services for the company and receives only distributions, they are not considered employees and are not subject to unemployment tax.

4. What happens if an S corp doesn’t pay a reasonable salary to an owner?

The IRS may reclassify distributions as wages and impose back taxes, penalties, and interest for unpaid employment taxes, including FUTA and FICA.

5. Are unemployment taxes the same in every state?

No. States set their own unemployment tax rates and wage bases. Some states also have different requirements for owner-employees.

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