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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 as part of their personal federal tax returns.

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. C-Corp shareholders are not taxed if they do not receive dividends. S-Corps shareholders, on the other hand, are taxed regardless of whether they receive dividends. As such, S-Corp shareholders can pay taxes on profits they never directly receive.

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.

This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.

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