Structuring your business as an S corporation enables income above a business owner’s reasonable compensation to be exempt from self-employment tax.
Commonly referred to as S corp, S subchapter, pass-through entity and flow-through entity
Do I Qualify for a S Corporation?
S corporations are not taxed at the corporation level; instead, they pass corporate income, losses, deductions and credits through to their shareholders for federal tax purposes, making them a pass-through entity.
2022 S Corporation Details
S corporations are not taxed at the corporation level. They pass corporate income, losses, deductions and credits through to their shareholders for tax purposes, making them a pass-through entity. S corporation shareholders report the income and loss on their personal tax returns and are assessed tax at their individual income tax rates, allowing the S corporation to avoid double taxation on corporate income.
Self-employment tax and distributions. One major benefit of an S corporation is that not all earnings are subject to self-employment tax. An S corporation shareholder is an owner-employee of the business. This means that the net profit from the business is a blend of self-employment income and a return of capital from the shareholder’s investment in the business.
The self-employment component is paid out as wages and is subject to self-employment tax. The return on the investment is paid out as a distribution and is not subject to self-employment tax.
Reasonable compensation. To prevent all of the business earnings from being treated as distributions that are not subject to self-employment tax, S corporation shareholders are required to be paid “reasonable compensation.” Amounts taken as reasonable compensation are treated as wages, and the shareholder and corporation pay FICA and Medicare taxes on those wages.
Since only a portion of the net profit is subject to self-employment taxes, business owners can see significant savings on self-employment taxes. These savings are available as long as the S corporation is in business. All net profit, whether distribution or wages (reasonable compensation), is still subject to income tax.
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Receive additional liability protection on the company.
Reduce taxable income.
Reduce self-employment tax.
Ongoing payroll is required.
A reasonable compensation analysis is recommended to support the calculation.
The business owner will have to file an additional 1120S tax return.
Assumptions When Taking the S Corporation
The business owner is eligible to be a shareholder in an S corporation.
The business owner has elected to incorporate or become an LLC that may be taxed as an S corporation.
Requirements to Claim the S Corporation
In order to be eligible for S corporation status, the business must:
Be a domestic corporation
Have only eligible shareholders, including individuals, estates and certain trusts
Have no more than 100 shareholders
Issue only one class of stock (stock can be split into voting/non-voting shares)
Not be an ineligible business, such as certain financial institutions, insurance companies and domestic international sales corporations
Partnerships, corporations and non-resident aliens cannot be shareholders in an S corporation.
Business Entities That Can Claim the S Corporation
The material discussed on this page is meant for general illustration and/or informational purposes only and is not to be construed as investment, tax, or legal advice. You must exercise your own independent professional judgment, recognizing that advice should not be based on unreasonable factual or legal assumptions or unreasonably rely upon representations of the client or others. Further, any advice you provide in connection with tax return preparation must comply in full with the requirements of IRS Circular 230.