Employment Taxes and Reporting
If your S corporation has employees, it must withhold employment taxes on their wages. Your corporation must periodically pay money to the federal government using electronic funds transfer. Additionally, your corporation needs to file quarterly employer tax returns (Form 941).
Estimated Tax Payments
Sometimes, an S corporation must make estimated tax payments. Generally, an S corporation must make installment payments of estimated tax if the total of these taxes is $500 or more:
- Tax on built-in gains
- Excess net passive-income tax
- Investment credit recapture tax
Income Reporting for Shareholders
S corporations must file Form 1120-S to report income, gains, losses, deductions, credits, etc. Complete Schedule K to list how much income is attributable to each shareholder for the taxable year. 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.
Tax Advantages and Rates
The main advantage of an S corp over a C corp is that an S corp does not pay a corporate-level income tax. Therefore, any distribution of income to the shareholders is only taxed at the individual level. All owners need to pay federal individual income taxes (top marginal rate of 39.6%), state, and local income taxes (from 0 percent to 13.3 percent).
Setting Aside Funds for Taxes
To cover federal taxes, saving 30% of your business income is advised. The total amount you should set aside to cover both federal and state taxes should be 30-40% of what you earn.
Penalties for Non-compliance
If the S corporation pays wages to employees, it must file an IRS Form 941 each quarter to report withheld amounts and remit to the IRS. If you fail to make estimated tax payments when required, you may be charged a penalty.
If you file Form 941 late, the IRS imposes a 5% penalty per month up to 25%. If tax liability and withholding is over $1,000 per year, you must file Form 941 quarterly.
Freelancers should set aside 25-30% of taxable income for income and FICA taxes, paying quarterly and any additional taxes owed. Use Form 1040-ES to calculate payments. Under a W-9, no taxes are withheld, so you must pay the IRS directly. You are also responsible for both employer and employee portions of Social Security and Medicare taxes.