How an S-Corporation Pays Taxes

Man Calculating the S-Corporation Income Taxes

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You may have been advised that you could become an S corporation and save the "double taxation" problem of being a shareholder in a corporation. Yes, an S corporation is taxed in a different way from corporations, and the owners of an S corporation don't have the double taxation problem, but before you decide to elect S corporation status, you should understand how an S corporation pays income taxes - and other taxes. 

What an S-Corporation Is

An S corporation (S Corp) is a special kind of corporation which operates as a corporation but is taxed on the individual shareholders' tax forms, for federal income tax purposes. 

S-Corporation and Federal Income Taxes

For tax purposes, an S corporation is considered a pass-through taxing mechanism. That is, the tax on the corporation is passed through to the owners for federal income tax purposes, but not the corporation itself. In all other ways, an s-corporation operates the same way as corporations.

  • First, the corporation files a corporate tax return on Form 1120-S.
  • Then each shareholder's share of the profit or loss of the corporation is recorded on a Schedule K-1.
  • The K-1 information for each shareholder is reported on Line 17 of the shareholder's Form 1040.

Most states use federal information to determine total income for state tax determination.

How S-Corporation Owners Get Taxed 

The owners of the S corp pay income taxes based on their distributive share of ownership, and these taxes are reported on their individual Form 1040. For example, if the profits of the S corp are $100,000 and there are four shareholders, each with a 1/4 share, each shareholder would pay taxes on $25,000 in profits.

Avoid the Double Taxation Problem

As noted above, shareholders of corporations pay tax on the dividends they receive from the corporation, in addition to the income tax imposed on the corporation itself. In an S corp, no tax is imposed on the corporation, and there are no dividends. 

S-Corporation Owners and Self-Employment Taxes

The owners of a corporation are shareholders and they receive dividends as a return on their investment. The owners of an S corporation pay regular income tax on their distribution, but they are not considered to be self-employed, so they pay no self-employment tax on this distribution. If any of the owners also are employees, they receive a salary, from with FICA taxes ({Social Security and Medicare tax) are withheld. So no self-employment tax is imposed on this S corp owner. 

Other Taxes Paid by S-Corporations

The S corporation pays the same taxes like other businesses, including: 

An S corporation must pay employment taxes on employee pay, including withholding and reporting federal and state income taxes, paying and reporting FICA (Social Security and Medicare) taxes, worker's compensation taxes, and unemployment taxes. Also, if the S corporation owns a building or other real property, property taxes are required to be paid on this property.

S corporations are required to pay state sales taxes and excise taxes in the same manner as other business types. Check with your state department of revenue for more information on sales and excise taxes.

Some states levy franchise taxes, state income taxes, or gross receipts taxes on S corporations each year. Check with your state department of revenue to see if your state requires these taxes.