How to Pay Taxes for an S Corporation

An S corporation offers a specific tax structure that distinguishes it from other business entities like C corporations or sole proprietorships. It is known as a “pass-through entity” for federal income tax purposes. This means that the business itself generally does not pay federal income tax; instead, its income, losses, deductions, and credits are passed through directly to the shareholders.

Shareholders then report these items on their personal income tax returns, paying tax at their individual income tax rates. This structure helps avoid the “double taxation” that can occur with C corporations, where profits are taxed at the corporate level and again when distributed to shareholders as dividends.

Understanding S Corporation Tax Obligations

S corporations and their shareholders face federal tax obligations. Business income, deductions, credits, and losses pass through to the shareholders’ personal income tax returns, meaning the S corporation generally does not pay federal income tax on its profits.

Shareholders report their share of the S corporation’s financial results on their personal Form 1040, U.S. Individual Income Tax Return, using information from Schedule K-1 (Form 1120-S). This schedule details each shareholder’s allocated portion of the S corporation’s income, deductions, credits, and other items, with the tax rate determined by their individual income tax rate.

S corporations that employ shareholders must also manage federal payroll taxes. Shareholder-employees are required to receive “reasonable compensation” for services provided. This compensation is subject to Social Security and Medicare taxes, known as FICA taxes, split between the employer and employee. The S corporation is responsible for withholding the employee’s portion and paying both portions, typically reported on Form 941, Employer’s Quarterly Federal Tax Return, and Form W-2, Wage and Tax Statement.

Certain federal taxes can still apply at the entity level for S corporations in specific situations. One such tax is the Built-in Gains Tax, imposed under Internal Revenue Code Section 1374. This tax applies to S corporations that were previously C corporations and recognize gains from the disposition of assets that appreciated in value during their C corporation years.

Another potential entity-level tax is the Excess Net Passive Income Tax, outlined in Section 1375. This tax applies if an S corporation has accumulated earnings and profits from its C corporation years and its passive investment income exceeds 25% of its gross receipts for the taxable year. Passive investment income includes royalties, rents, dividends, and interest.

State tax obligations for S corporations vary significantly across jurisdictions. Many states recognize the federal S corporation election and follow the pass-through taxation model, but others may impose entity-level taxes. These state-level taxes can include income taxes, franchise taxes, or gross receipts taxes. Businesses must consult their specific state’s tax laws to understand their obligations.

Gathering Information for Federal Tax Reporting

Accurate financial record-keeping is essential for federal tax reporting. Businesses must maintain detailed records of all income, expenses, balance sheet items, payroll records, and asset purchases or sales throughout the tax year to prepare federal tax forms.

Tracking shareholder basis is important for S corporation owners. This refers to a shareholder’s investment in the S corporation’s stock and any direct loans made to the corporation, impacting the deductibility of losses passed through to shareholders and the taxability of distributions received.

Determining “reasonable compensation” for shareholder-employees directly influences payroll tax obligations and the amount of profits available for distribution. The Internal Revenue Service (IRS) defines reasonable compensation as the value ordinarily paid for similar services by similar enterprises under similar circumstances. Factors considered include the shareholder’s training and experience, duties and responsibilities, time and effort devoted to the business, and what comparable businesses pay for similar services.

The primary federal form for S corporations is Form 1120-S, U.S. Income Tax Return for an S Corporation. This form serves as the S corporation’s informational return to the IRS, reporting its income, gains, losses, deductions, and credits for the tax year.

Accompanying Form 1120-S is Schedule K-1 (Form 1120-S). This schedule is prepared for each shareholder and reports their individual share of the S corporation’s income, deductions, credits, and other items. Shareholders use this information to complete their personal income tax returns.

For payroll reporting, S corporations use Form 941, Employer’s Quarterly Federal Tax Return, to report withheld federal income tax, Social Security, and Medicare taxes. Annually, Form W-2, Wage and Tax Statement, is issued to each employee, including shareholder-employees, summarizing their wages and withheld taxes.

The S corporation’s net income or loss is calculated by aggregating all income and allowable deductions. This net amount is then allocated to shareholders based on their ownership percentage.

Making Federal Tax Payments

After gathering information and calculating tax liabilities, federal tax payments are made. While the S corporation generally avoids federal income tax, shareholders pay income tax on their share of the business’s profits, necessitating individual estimated tax payments throughout the year.

Individuals, including S corporation shareholders, must make estimated tax payments if they expect to owe at least $1,000 in tax when filing their personal return. These payments cover income tax and self-employment taxes on non-wage income. Estimated taxes are paid in four installments throughout the year, with due dates in April, June, September, and January of the following year.

One method for making federal tax payments is through the Electronic Federal Tax Payment System (EFTPS). This system allows businesses and individuals to make electronic payments for all types of federal taxes, including estimated taxes and payroll tax deposits. Payments can also be made directly from a bank account using IRS Direct Pay or by mail with a check or money order.

S corporations with employees, including shareholder-employees, have requirements for depositing federal payroll taxes. These deposits, covering Social Security, Medicare, and federal income tax withholding, are made through EFTPS. The frequency of these deposits (e.g., daily, weekly, monthly) depends on the amount of accumulated tax liability.

If an S corporation is subject to entity-level taxes, such as the Built-in Gains Tax or Excess Net Passive Income Tax, separate payments for these taxes are required. These payments are submitted directly by the S corporation to the IRS. Payment deadlines for these entity-level taxes align with the filing deadline for Form 1120-S, which is March 15 for calendar-year filers, or the 15th day of the third month after the end of the tax year.

Navigating State Tax Requirements

State tax obligations for S corporations present a complex landscape due to varying state approaches. Many states conform to federal S corporation tax treatment, taxing shareholders at the individual level, but some states impose their own entity-level taxes.

These entity-level state taxes can take various forms, such as franchise taxes, often based on net worth or capital, or gross receipts taxes, levied on the business’s total revenue. Certain states may even impose a corporate-level income tax on S corporations, sometimes at a reduced rate compared to C corporations. Understanding these state-specific nuances is important for compliance.

Most states require S corporation shareholders to report their share of the S corporation’s income on their personal state income tax returns, similar to federal reporting. This ensures the income is taxed at the individual’s state income tax rate. Shareholders must be aware of their home state’s rules for reporting pass-through income.

Beyond income and entity-level taxes, S corporations, like other businesses, may be responsible for collecting and remitting sales tax if they sell taxable goods or services within a state. Sales tax rules vary by state, encompassing different tax rates, taxable items, and reporting frequencies. Businesses must register with the appropriate state tax authority for sales tax purposes.

S corporations with employees incur state payroll tax obligations. These include state unemployment insurance (SUI) contributions, which fund unemployment benefits for eligible workers. Some states also require contributions for state disability insurance (SDI), providing benefits for non-work-related illnesses or injuries. These state payroll taxes are employer-funded, though a few states require employee contributions for SUI or SDI.

Given the diversity in state tax laws, S corporations must research and understand the registration, filing, and payment requirements for each state in which they operate. This often involves consulting state tax agency websites or seeking professional tax advice to ensure compliance with state-level obligations.