There are a number of advantages (and a few disadvantages) to becoming an S Corp (and filing S Corp taxes). With S Corp status, your personal assets are protected in case the business is sued. If you are currently an LLC, then you already have this type of protection from a legal standpoint but you will be able to tap into the tax advantages that an S Corp status will bring. In this article, we will discuss the tax advantages of an S Corp as well as the when it makes sense to become an S Corp, tax returns required, and more.
What is an S Corp?
S corporations are corporations that (for tax purposes) elect to pass through their income, loss, deductions and credits to the owners (often referred to as shareholders) of the company. The S Corp is responsible for completing and submitting Form 1120S to the IRS and for providing each shareholder with a Schedule K-1 to report their share of net earnings on their personal tax returns.
S Corp Taxes: Advantages
In general, most people who are considering S Corp status are business owners who are currently LLCs taxed as either sole props or partnerships. A couple of advantages that you will benefit from as an S Corp are:
- You will no longer have to pay self employment taxes on net earnings of the business. Instead, owners of an S Corp can draw a salary, and they will share the cost of social security and medicare taxes (also known as FICA taxes) with the S Corp. To learn more about FICA, check out our guide.
- If you’re contemplating S Corp or C Corp status, S Corp does not have the “double taxation” that C Corps come with. Since a C Corp is recognized as a taxable entity, the Corporation is taxed on its net earnings, and any earnings that are distributed to the owners in the form of dividends are taxed again when reported on the owner’s personal income tax return.
Below, you will find a summary table that compares the pros and cons of S Corps, C Corps, and LLCs:
S Corp Taxes vs. C Corp Taxes: Pros & Cons Summary Table
|Type of Corporation||Pros||Cons|
|LLC treated as a Sole Prop or Partnership||
When It Makes Sense To Become an S Corp
Making the S Corp election probably makes the most sense during the initial years that you are in business. Since tax losses are common in the early years due to start-up costs, your tax bill may be significantly reduced since you can offset income on your personal tax return with your share of the losses from the S Corp.
Another situation in which you may want to elect S Corp status is if the tax bracket that you are in is lower than what the corporate tax rates are. As an S Corp, you pay net earnings based on your individual tax bracket; whereas a C Corp would pay corporate tax rates.
You should also be aware that the requirements vary from state to state for S Corps. Be sure to read the State Obligations section for more info.
What are the Qualifications to be an S Corp?
In order to qualify for S Corp status, the company must meet all of the following requirements:
- Must be a domestic company.
- Must only have shareholders that are individuals, certain trusts or estates
- Must not have shareholders who are partnerships, corporations or nonresident alien shareholders.
- No more than 100 shareholders.
- Have only one class of stock.
- Not be an ineligible corporation. This includes certain financial institutions, insurance companies and domestic international sales corporations.
If you meet all of the above requirements, then you need to take the following steps to become an S Corporation:
- Complete Form 2553 (Election by a Small Business Corporation) and make sure it is signed by all shareholders.
- Submit Form 2553 no more than 2 months and 15 days after the beginning of the tax year that the S Corp election is to take effect. For example, if you want to be treated as an S Corp for the tax year 2017, then Form 2553 would have to be filed no later than March 15, 2017. Information on where to mail or fax Form 2553 can be found here.
What are the Self-Employment Tax Requirements?
Shareholders of an S Corp are not subject to self-employment tax on their share of net earnings from the corporation. However, if a shareholder receives a salary, FICA (social security and medicare) tax will be deducted from their paycheck. In addition, the S Corp will be responsible for paying the employer’s share FICA tax. More info on how FICA works and your responsibility as an employer can be found here.
S Corp Tax Returns Required
At a minimum, an S Corp must file Form 1120S and Schedule K-1. However, if the S Corp also has shareholders who draw a salary, then the S Corp is responsible for payroll taxes as well. Payroll taxes include FICA (discussed earlier), federal tax withheld from all employee paychecks and unemployment taxes. Payroll taxes are reported on Forms 940 and 941.
If you’re in the market for a payroll software program, you should check out Gusto. Gusto is our recommended payroll software for small businesses. It will automate payroll for you by calculating paychecks, computing payroll taxes for you and it will automatically transfer your payroll data to the payroll tax forms so that you can easily file & pay on time.
Below you will find a summary table listing each form that is required to report S corp taxes along with a brief description.
Summary Table of S Corp Tax Forms
|Form 1120S||An information return that must be filed to report all income, deductions, credits and losses of the business. You can learn more about how to complete Form 1120S here.|
|Schedule K-1||A form that is used to pass through the income, deductions, credits and losses of the S Corp to it’s shareholders. This form is used to report the shareholder’s share of net earnings on their personal tax return.|
|Form 940||The tax form that all employers must file annually to report payments made for unemployment taxes. To learn more about Form 940 and FUTA, check out our guide.|
|Form 941||A tax form that employers must file quarterly to report income tax and FICA taxes withheld from employee paychecks; the employer’s share of FICA taxes is also included on this form. You can find more info on FICA tax and Form 941 here.|
S Corp Taxes: State Obligations
We have focused primarily on the Federal tax obligations of an S Corp. However, each state has it’s own set of requirements. For example, the District of Columbia, New Hampshire, Tennessee, Texas and Louisiana tax S corps in the same manner as C corps. In other words, the S corp pays taxes on all net earnings, it does not pass through to each shareholder.
For more info on what your state requires, check out this state tax guide.
The Bottom Line
I’m sure that you would agree that It’s important for you to know what your tax obligations are as a business owner. What makes it even more challenging is the different requirements at the federal, state and local levels. Now that you know how S Corp taxes work at the federal level, I recommend you use an accounting software like QuickBooks to keep track of everything you need to file them. Click here for a free trial.