S corporations (S-corps) are corporations and limited liability companies (LLCs) that have elected to pass through their income, deductions, and credits to be taxed on the owner’s tax return. S-corp tax rates are the same as the personal income tax rates because the owners pay S corporation taxes on their share of the company’s income.
S corporation taxation can get tricky, especially since the company usually needs to pay salaries to its shareholders. It’s important to keep track of the S-corp’s income and expenses. Consider using QuickBooks to keep track of your S corporation’s finances. Save up to 50% off QuickBooks Online.
What Is an S Corporation?
An S corporation is a corporation or limited liability company that elects to be taxed under subchapter S for federal taxes. Subchapter S provides that the S-corp’s income, deductions, and credits flow through to the shareholders (owners) and are taxed on their individual returns. The income reported on the shareholder’s tax return is usually not affected by the amount of cash distributed by the S corporation to the shareholder.
How S Corporation Taxes Work
Shareholders of S corporations receive taxable income in two ways. First, if the shareholder performs services for the S corporation, they must be paid a salary. Second, any remaining S corporation income is taxed to the shareholder as ordinary income. Notice that total income to the shareholder is the same no matter how much salary is paid. If shareholder salary increases, remaining S-corp income decreases by the same amount.
While shareholder salary doesn’t affect the total income reported by the shareholder, it does affect the total taxes paid. This is because salary is subject to payroll taxes while the remaining S-corp income is not. Shareholders could minimize their total tax by not paying any salary, but that is not allowed. Shareholders must be paid a fair value for their services.
S Corporation Taxes vs Partnership Taxes
Like S corporations, partnerships pass through income, deductions, and credits to the partners’ returns. However, there are some very important differences between S corporation and partnership taxation:
- Owner salaries: Partners are not allowed to be employees of the partnership. Payments to partners for services performed are called guaranteed payments and are not included in Form W-2 like employee wages.
- Self-employment tax: Partners have to pay self-employment tax (in addition to income tax) on both guaranteed payments for services and the ordinary income from the partnership. While S corporation shareholders pay payroll taxes on their salaries, they do not have to pay self-employment tax on the ordinary income from the S-corp.
- Asset transfers: Assets (like real estate) can be transferred into either an S corporation or partnership without recognizing a gain or loss. However, assets transferred out of an S corporation can trigger a recognized gain by the shareholder, whereas assets transferred out of a partnership will not trigger a gain. Consult a tax professional before transferring real estate into an S corporation, because you can’t get it back out without paying tax.
S Corporation Taxes vs C Corporation Taxes
C corporations are corporations and certain LLCs that have not elected to be treated as S corporations. The taxation of C corporations is quite different from the taxation of S-corps:
- Income, deductions, and credits: C corporations must calculate and pay income tax at the corporate level. Unlike S corporations, C corporation earnings have no effect on the shareholder’s tax return.
- Shareholder distributions: Shareholders of C corporations must pay tax on shareholder distributions, or dividends, received from the corporations. Because the C corporation has already paid tax on this income at the corporate level, this tax on dividends is often referred to as double taxation. S corporations are not subject to double taxation because shareholder distributions are generally tax-free.
- Owner salaries: Like S corporations, owners of C corporations must be paid a fair salary for services performed, and the payments are reported on Form W-2 like any other employee. The C corporation receives a deduction so there is no double taxation of salaries.
S Corporation Pitfalls to Avoid
S corporations generally receive favorable tax treatment compared to C corporations and partnerships, but there are some situations that business owners need to avoid:
- Owning real estate: It is usually not advisable for an S corporation to own real estate because a gain might be recognized if the property is later transferred from the S corporation to the shareholder. It is better to own the property outside the S corporation and lease it to the S corporation.
- Unequal shareholder distributions: All S corporation distributions to shareholders are required to be pro-rata based on their ownership percentage. Unequal distributions can result in a business being taxed as a C corporation and paying tax on their business income tax return.
- Disguised shareholder salaries: Shareholders must be paid a fair salary for services performed. Some S corporations will try to avoid payroll tax by misclassifying salary payments as distributions. The IRS can reclassify these payments as salary and assess payroll taxes and stiff penalties.
S Corporation Tax Rates
S corporations generally do not pay federal corporate income tax. S corporation shareholders report their share of S-corp income on their personal tax returns. Thus, S-corp income is taxed at personal income tax rates. For 2018 and later, most S corporation shareholders can reduce the ordinary income that flows through from their S corporation by 20%, referred to as the Qualified Business Income Deduction, or 199A deduction.
Qualified Business Income (199A) Deduction
Single taxpayers with total income on their personal tax returns of less than $160,700 in 2019 ($321,400 married) will automatically qualify for the 199A deduction. Taxpayers with income in excess of this amount will likely still qualify for the 199A deduction depending on the wages paid, assets owned, and industry of the S corporation.
If a shareholder qualified for the 20% 199A deduction, his income from the S corporation is reduced by 20%. This effectively reduces the tax rate on the S corporation income by 20%.
2019 S Corporation Individual Tax Rates
Single With Taxable Income of | Married With Taxable Income of | Individual Tax Rate | Effective Tax Rate on S-corp Income With 199A Deduction |
|---|---|---|---|
$0 to $9,700 | $0 to $19,400 | 10% | 8% |
$9,701 to $39,475 | $19,401 to $78,950 | 12% | 9.6% |
$39,476 to $84,200 | $78,951 to $168,400 | 22% | 17.6% |
$84,201 to $160,725 | $168,401 to $321,450 | 24% | 19.2% |
$160,726 to $204,100 | $321,451 to $408,200 | 32% | 25.6% |
Over $204,101 | Over $408,200 | 35% | 28% |
How to File S Corporation Taxes
An S corporation must file Form 1120S, including Schedule K-1. An S-corp typically has employees, and this requires running payroll and filing payroll tax returns, including Form 940 and Form 941. S-corps will also need to issue Form W-2 to employees and Form 1099-MISC to independent contractors.
The tax forms required to be filed by most S corporations are:
S-corp Tax Filing Forms
Tax Form | Description |
|---|---|
Form 1120S | Income tax return for the S-corp; learn how to complete Form 1120S |
Schedule K-1 | This form is part of the Form 1120S and reports each owner’s share of net earnings of the S-corp |
Form 940 | Annual payroll tax return for federal unemployment taxes (FUTA) |
Form 941 | Quarterly payroll tax return for federal withholding and FICA taxes |
Form 1099 | Report payments made to independent contractors using Form 1099 |
Form W-2 | Report wages paid to employees on Form W-2 |
When Federal S-corp Taxes Are Due
The due date for S corporation tax return, Form 1120S, is March 15 for S corporations that report on the calendar year, which is most S corporations. For S-corps with a fiscal year, the due date is the 15th day of the third month following the end of the fiscal year.
Tips for S-corp deadlines include:
- Fiscal year: With a fiscal year ending on June 30, for example, the due date is Sept. 15.
- Extensions: S-corps can request an additional six months to file their Form 1120S. Request an extension using Form 7004. To be a valid extension, Form 7004 must be filed by the original due date.
- Weekends and holidays: If the due date falls on the weekend or a federal holiday, then the due date is the following business day.
Other Tax Responsibilities for S-corps
Some other responsibilities for S-corp taxes you should consider are:
- State S-corp taxes: In most states, S-corps file state tax returns and may have to pay state taxes. S-corps may need to withhold state tax on income allocated to shareholders who live outside the state where the S-corp conducts business. Be sure to do your research at your state tax agency website on what taxes an S-corp is required to pay.
- Collect sales tax: If you sell products or services that are taxable, then you must collect sales tax from your customers and report and pay that tax to the state authorities.
- Register in states where conducting business: Each state has its own rules for what counts as conducting business in a state.
- City business license or registration: The S-corp may need to obtain business registrations or business licenses in the cities where it conducts business operations.
- Pay estimated tax: The shareholders of the S-corp may need to make estimated income tax payments (both federal and state) so that any tax related to their S-corp income is paid throughout the year.
- Personal tax returns: The shareholders of the S-corp will need to file their own personal tax returns reporting their share of the income from the S-corp.
To help you keep track of your responsibilities, we’ve created a free S-corp taxes checklist.
How to Get S-corp Status
A business must satisfy six requirements to elect S-corp status. These requirements limit how many owners a business can have as well as the types of people or entities that can be owners. If you qualify, prepare Form 2553 and submit it to the IRS.
1. Qualify as an S-corp
In order to qualify for S-corp status, your company must:
- Be a domestic company
- Only have shareholders who are individuals, certain trusts, or estates
- Not have shareholders who are partnerships, corporations, or nonresident alien shareholders
- Have no more than 100 shareholders
- Have only one class of stock
- Not be an ineligible corporation, including certain financial institutions, insurance companies, and domestic international sales corporations
2. Prepare & Submit Form 2553 to the IRS
Once you have determined that you qualify as an S-corp, you need to complete Form 2553 (Election by a Small Business Corporation) and have it signed by all shareholders.
The deadline for submitting Form 2553 varies based on your firm’s situation:
- Newly formed corporation: Submit Form 2553 to the IRS no later than two months and 15 days from the date of incorporation.
- Existing C corporation electing for next tax year: Submit Form 2553 any time during the current year and no later than two months and 15 days from the beginning of the next year.
- Existing corporation requesting retroactive S-corp status: Submit Form 2553 no later than three years and 75 days from date the owners intended for S-corp status to take effect. Shareholders will need to explain why they are late in filing the election.
Bottom Line
Filing taxes as an S corporation may have many advantages for your business. However, it’s important to always consult a tax professional before making an election as an S-corp. Be sure to weigh all the options available and choose the business structure that works for you.
Regardless of your business structure, we recommend using QuickBooks to keep track of everything you need to file your taxes. This accounting software tracks all income and expenses and compiles the information you need to fill out S-corp taxation documents. Get started and save up to 50% off QuickBooks Online.
