Some states such as New York and New Jersey require a separate state-level S election in order for the corporation to be treated, for state tax purposes, as an S corporation. The corporation must complete a Schedule K-1 for each person who was a shareholder at any time during the tax year and file it with the IRS along with Form 1120S. The second copy of the Schedule K-1 must be mailed to the shareholder. The distribution of the additional profits from the S corporation will be done without any further FICA tax liability. Sole proprietorship is the simplest structure for a one-owner business, giving the owner few regulatory burdens and a high degree of control and flexibility. It is, of course, possible to change the structure of a business if the nature of the business changes to require it, but doing so often might involve incurring a tax penalty of one kind or another.
- S corporation status doesn’t alter the business operations, but it moves the tax burdens from the business to the owners themselves.
- Then, those profits are passed along to its shareholders in the form of dividends.
- Unless you are a tax expert or an accountant, you may be banging your head into your desk after the first few pages.
- If you’re an unincorporated business such as a general partnership, a qualified joint venture, or a sole proprietor working under a “doing business as” (DBA) name, you must form a legal business entity to become an S corporation.
- In Philadelphia, S corporations are subject to the city’s income tax (6.35%) and gross receipts tax (1.415%), but not the net profits tax (3.8907%).
- Unlike a traditional corporation, because an S-corporation is a pass-through entity, the information on your S-corp tax return will be more informational.
If your business is structured as a corporation, S-corp taxation allows you to avoid having company profits taxed at both the corporate and shareholder level. If your business is an LLC, S-corp taxation allows you to be a company employee, potentially saving money on taxes. One of the key features of an S-corporation election for a corporation is pass-through taxation. While C-corps are subject to “double taxation” where distributions to shareholders are taxed twice, S-corps are not subject to corporate income tax, so distributions are only taxed once—when received by shareholders. This tax arrangement works well for many LLCs, but as the business becomes more profitable it may make sense to consider electing S-corp taxation. With S-corp status, owners can be company employees, as long as they pay themselves a reasonable salary.
Maintaining your tax status under Subchapter S of the Internal Revenue Code
This arrangement is referred to as “double taxation” and has historically been viewed as the price to pay for a corporation’s limited liability advantages. Generally, S corps are not taxed at the corporate level and instead have pass-through taxation which means that profits, credits, deductions, and losses pass directly to the individual shareholder as in a default LLC. In contrast to S corps, C corporations (C corps) are more complicated to run and have double taxation, since they are taxed at the business level and at the shareholder level after.
- S corp shareholders are considered employees, which means they must only pay a portion of their Medicare and Social Security taxes, while the S corp covers the rest.
- The other $30,000 will still be subject to income tax, but not Medicare or Social Security taxes.
- The IRS is more restrictive regarding ownership for corporations that file for S corporation tax status.
- S-corp shareholders only pay self-employment tax on the salary component of income, while distribution income isn’t subject to self-employment taxes.
- But like partnerships, they don’t pay corporate taxes on any earnings and income that they generate.
Choosing the appropriate business structure is important and should not be taken lightly. Think hard about the kind of business you intend to start and operate, then review your options and choose the one that best fits your business’s purpose and goals. Whichever option you choose, running a small business is not easy, so make sure you have the right legal resources available to set up and operate an LLC. Also, as an LLC owner, you are liable for higher self-employment taxes, which is something many entrepreneurs try to avoid.
Definition and Example of an S Corp
Learn how an S corporation pays taxes, why it can be beneficial to pay taxes this way, how to select S corporation status, and some pros and cons of S corporations. If you’re an unincorporated business such as a general partnership, a qualified joint venture, or a sole proprietor working under a “doing business as” (DBA) name, you must form a legal business entity to become an S corporation. Based on these factors, the score card could tip what is an s-corporation (s-corp)? either way for your small business. A seasoned tax professional can determine which would provide the greater tax advantage for your business. A corporate attorney can advise you on the complexities of ownership and profit distribution. For a small business, operating as an S corporation avoids the “double-taxation” that would otherwise be paid if both the corporation and shareholder paid tax on the income distributed to its shareholders.
S corporation status passes corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. The S corporation shareholders report the flow-through of income and losses on their personal tax returns. Like a C corporation, an S corp is a separate entity that has to follow certain filing rules and processes to operate legally.
