Corporate Taxation: How an S-Corp is taxed

One of the biggest reasons business owners choose S-Corps over C-Corps is tax-related. Simply, S-Corps are generally exempt from federal income tax and, therefore, are not taxed at the corporate level.

This means no double-taxation.

This also means that shareholders pay taxes on their personal returns, while the company itself passes the profit (or losses) directly to those shareholders. As such, an S-Corp is a “pass-through entity,” much in the way an LLC is.

So how does it work?

First off, an S-Corp must pay its employees a “reasonable salary,” which itself is subject to taxes like Medicare or Social Security. After that, the S-Corp distributes profits in the form of dividends to its shareholders. These shareholders will pay taxes on those dividends.

There’s one important thing to keep in mind here, though. In a C-Corp, the business can choose to retain their profits as operating capital. The shareholders are not taxed individually if a C-Corp retains these profits. On the other hand, regardless of whether shareholders receive their portion of dividends from a S-Corp, they are taxed. As such, S-Corp shareholders can effectively pay taxes on profits they never personally received, but which the company, of course, did.

S-Corps will have to fill out IRS Form 1120S.

You can learn how a C-Corp is taxed here, or get more information below in our Incorporation Learning Center.

 

Laws on this topic may vary from state to state. This content is not meant to provide you with complete information and it is not intended to be legal or tax advice. It is recommended that you consult with your own attorney, accountant or other advisor regarding your specific situation.