Is S Corp Income Subject to Self Employment Tax?
Navigate S corp income and self-employment tax. Understand the key distinctions that impact your tax liability as an owner.
An S corporation offers a distinct tax structure, often leading to questions about how its income is treated for tax purposes, particularly concerning self-employment tax. This article clarifies the relationship between S corporation income and self-employment tax, providing insights into the tax implications for owner-employees.
Understanding S Corporation Income
An S corporation is a tax election that permits a business to pass its income, losses, deductions, and credits directly through to its shareholders’ personal income. The business’s profits and losses are reported on the owner’s personal tax return via a Schedule K-1.
This “pass-through” characteristic avoids the double taxation that C corporations face, where corporate profits are taxed at the corporate level and again when distributed to shareholders as dividends. The S corporation structure allows business income to be taxed only once, at the individual shareholder level.
Self-Employment Tax Fundamentals
Self-employment tax consists of Social Security and Medicare taxes, applying to individuals who work for themselves. It functions similarly to the FICA taxes withheld from traditional wage earners’ paychecks.
For 2025, the Social Security portion is 12.4% on net earnings up to $176,100. The Medicare portion is 2.9% on all net earnings from self-employment. The combined self-employment tax rate is 15.3% on earnings up to the Social Security wage base, and 2.9% on earnings above that threshold. This tax is calculated on 92.35% of net earnings from self-employment.
Applying Self-Employment Tax to S Corporation Income
While an S corporation’s pass-through income is not subject to self-employment tax, the salary paid to an owner-employee is. The Internal Revenue Service (IRS) requires S corporation owner-employees to pay themselves “reasonable compensation” for services performed. This salary is subject to Social Security and Medicare taxes, similar to FICA taxes paid in a traditional employment setting.
This distinction prevents owners from reclassifying all income as distributions to avoid Social Security and Medicare taxes. The IRS defines reasonable compensation as the amount similar businesses would pay for similar services. Factors considered include the owner’s training, experience, duties, responsibilities, time, effort, and the company’s financial condition. Failing to pay a reasonable salary can lead to IRS reclassification of distributions as wages, resulting in penalties and back taxes.
Distributions and Self-Employment Tax
After an S corporation owner pays a reasonable salary for their services, any additional profits can be taken as distributions or dividends. These distributions are not subject to self-employment tax. This is a primary tax advantage of the S corporation structure compared to a sole proprietorship or partnership, where all business income remains subject to self-employment tax.
This separation between salary and distributions is a key aspect of tax planning for S corporation owners. By paying a reasonable salary subject to employment taxes and taking remaining profits as distributions, owners can reduce their overall self-employment tax liability.