Introduction to S Corporations
An S corporation (S Corp) passes income directly to owners. The owner’s salary pays employment taxes and income tax. Distributions only pay income tax. This leads to S corp tax savings. If you’re a business owner making over $60,000 in earnings with $20,000 in annual distributions, let ZenBusiness start your S corp to start growing your business.
Taxation and Savings in S Corporations
- S-corporations, like partnerships, are pass-through entities. Profit is allocated to shareholders and taxed at their income tax rates. This is usually more efficient.
- Shareholders report income and losses on personal tax returns at individual rates. This allows S corporations to avoid double taxation.
Qualifications and Filing of S Corporations
To qualify for S corporation status, the corporation must: be a domestic corporation, have allowable shareholders, have no more than 100 shareholders, and have only one class of stock.
- S corporations file an information return but do not pay income taxes themselves. Instead, income passes through to shareholders who report it on their personal returns. Shareholders get a K-1 showing their share. Employment taxes still apply to shareholder salaries.
- Most companies elect S-Corp status to avoid the double taxation that C-Corporations get subjected to. S-Corps do not get taxed twice entirely.
- S corporation shareholders do not pay self-employment tax on business profits. The big benefit is avoiding double taxation on corporate income.
Benefits and Considerations of S Corporations
- A major advantage of an S corp is tax savings versus a regular C corporation. S corps avoid double taxation of dividends. Income is only taxed once at the shareholder level.
- S corps avoid some payroll taxes. Shareholders only pay these taxes on the salary portion of income, not on distributions. This saves on Medicare and Social Security taxes.
- If an S corp earned $100,000, the shareholder could take a $40,000 salary and $60,000 distribution. This avoids payroll taxes on the $60,000.
- There are potential downsides of an S corp like formation costs, franchise fees, and record keeping. Also, income sources are restricted to active business activities.
- In summary, an S corp offers tax savings versus a corporation. Income passes through to shareholders, avoiding double taxation. Shareholders avoid some payroll taxes on distributions. However, extra administrative costs are involved.