S Corporation Basics
An S corporation (S Corp) is not taxed at the business level. The S Corp income passes through to the owner’s tax return as salary and distributions. The owner’s salary pays employment taxes and income tax. Distributions only pay income tax, which leads to S Corp tax savings.
An S Corporation reduces self-employment/payroll taxes versus a sole proprietorship or partnership. Employment, payroll, and self-employment taxes apply to salaries. S corps avoid double taxation versus C corps, where C corps pay taxes on profits when earned, and S corps pass income to shareholders without federal taxes.
S Corp Filing and Taxes
IRS S Corp Requirements:
- Fewer than 100 shareholders
- U.S. citizen shareholders
- Not owned by another business
- Shareholder participation
S corps pay California a 1.5% franchise tax on net income. The $800 minimum tax applies, except the first year. To file as an S corp in California:
- No filing fee
- Meet requirements
- Make election within 2 months and 15 days of first taxable year
An S Corp calculator estimates potential tax obligations under different structures, including an S Corp versus LLC comparison. It provides an idea of possible tax savings to help decide between filing as an LLC or S Corp.
Potential S Corp Disadvantages:
- Formation and ongoing expenses
- Tax qualification obligations
- Must use calendar year
S Corps don’t pay federal income taxes so there’s no real “S Corp tax rate." Instead, shareholders report the income/losses on their personal returns, avoiding double taxation.
Calculating Shareholder Income
To calculate S Corp income per shareholder:
1) Divide Form 1120S income by total shares
2) Multiply by each shareholder’s shares
3) Report on Schedule K
S Corp Tax Advantages and Considerations
Does S Corp really save taxes? An S Corp can be a special corporation that avoids double taxation of profits. To qualify, an S Corp must have 100 or fewer shareholders who are U.S. citizens. It also cannot be owned by another business.
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. This can result in significant savings.
S Corps also avoid some payroll taxes. Shareholders only pay these taxes on the salary portion of income, not on distributions. This is a major loophole that saves on Medicare and Social Security taxes.
In summary, an S Corp offers major tax savings versus a regular corporation. Income passes through to shareholders and avoids double taxation. Shareholders also avoid some payroll taxes on distributions. However, some extra administrative costs are involved.