How Much Does an S Corp Pay in Taxes?

An S Corporation is a business entity that has elected a distinct tax status with the Internal Revenue Service (IRS), allowing it to avoid the federal income tax treatment applied to traditional C Corporations. The primary distinction lies in how the business’s profits and losses are handled for federal tax purposes.

The Pass-Through Tax Model

The fundamental concept governing S Corporation taxation is the “pass-through” model. Under this structure, the S Corporation itself does not pay federal income tax. Instead, its income, deductions, gains, and losses pass directly to shareholders’ personal income tax returns. This prevents “double taxation,” where C Corporations pay tax on profits and shareholders are taxed again on dividends.

An S Corporation files an informational return with the IRS, Form 1120-S. This form reports the company’s financial activities but does not calculate a corporate income tax liability. It informs the IRS and shareholders of their respective shares of the business’s financial outcomes.

Income and losses are allocated to shareholders based on their ownership percentage. Each shareholder receives a Schedule K-1 (Form 1120-S), detailing their share of the corporation’s income, deductions, and credits. Shareholders use this information to report amounts on their personal income tax return, Form 1040, where income is taxed at individual rates.

Entity-Level Tax Responsibilities

Despite its federal pass-through status, an S Corporation has specific entity-level tax and financial obligations. These primarily involve payroll and various state taxes.

As employers, S Corporations must withhold and pay employment taxes. This includes FICA taxes (Social Security and Medicare) for all employees, including owner-employees receiving a salary. Both employer and employee contribute to these taxes, with the employer’s share being a deductible business expense. S Corps are also liable for Federal Unemployment Tax Act (FUTA) taxes, which fund state unemployment.

While federal income tax passes through, many states impose their own taxes on S Corporations. These can include state corporate income taxes or other entity-level taxes. States may also levy franchise taxes, fees for doing business, or gross receipts taxes based on total revenue. Annual registration fees are common in many states.

In specific circumstances, an S Corporation might be subject to federal entity-level taxes. The built-in gains tax applies if a C Corporation converts to an S Corporation and sells appreciated assets within a five-year recognition period. This tax is imposed on gains existing when the C Corporation elected S status. The LIFO recapture tax triggers when a C Corporation using the Last-In, First-Out (LIFO) inventory method converts to an S Corporation, ensuring deferred LIFO income is recognized and taxed.

Shareholder Tax Obligations

For S Corporation shareholders, personal tax obligations involve more than just reporting passed-through income. Income characterization, particularly between salary and distributions, directly impacts an owner’s individual tax liability.

S Corporation profits and losses, reported on Schedule K-1, flow directly to a shareholder’s personal tax return (Form 1040) and are taxed at individual rates. This ensures business income is taxed only once at the individual level. Shareholders are taxed on their income share, even if not distributed.

S Corp owner-employees must pay themselves a “reasonable salary” for services performed. The IRS mandates this to prevent owners from reclassifying salary as distributions to avoid FICA taxes. This salary is subject to federal income tax withholding and FICA taxes (Social Security and Medicare), like any other employee’s wages.

Distributions, amounts taken from the business beyond salary, are tax-free up to the shareholder’s basis in their S Corporation stock. Unlike partnership income, S Corp distributions are not subject to self-employment taxes if a reasonable salary has been paid. If distributions exceed stock basis, the excess is taxed as a capital gain.

S Corporation shareholders may qualify for the Section 199A Qualified Business Income (QBI) deduction. This allows eligible taxpayers to deduct up to 20% of their qualified business income, subject to income limitations and rules related to W-2 wages and qualified property. This deduction can provide significant tax savings for S Corp owners.

A shareholder’s basis in S Corporation stock is adjusted annually. This accounts for their share of the S Corp’s income, losses, and distributions. Maintaining an accurate basis is important as it determines the taxability of future distributions and gain or loss if stock is sold.