One of the main benefits people mention when becoming an S corporation is the ability to avoid double taxation that shareholders and other corporations may face. Avoiding double taxation is one of the benefits of becoming an S corporation, because S corps are taxed differently than other corporations. The team at Evolution Tax and Legal is breaking down S corp taxes: what types of taxes S corps must pay, how much they’ll pay, and how shareholders are taxed.
How Are S Corps Taxed?
An S corporation is a type of business that operates as a corporation but is taxed on the individual shareholders’ tax forms for federal income tax purposes. All S corporations must be a domestic corporation, so they are located within the United States and will be required to file taxes each year with the IRS. For tax purposes, S corporations are taxed as a pass-through taxing mechanism. This means that the tax on the S corporation will be passed through to the owners, where it will be filed on the individual’s federal income tax return. The owners of an S Corp will pay income taxes on their distributive share of the S corp profits, that is paid by the amount of stake they own in the company. For example, if the profits of an S corp are $30,000 and three owners all have an equally distributed share of the company, each owner will pay $10,000 on their individual tax return.
How S Corps Pay Federal Income Taxes
An S corporation will pay federal income tax first by filing Form 1120S, which is the corporate income tax return. The share of the loss or profit for each shareholder or owner will be in the Schedule K-1, which provides information to the shareholders for reporting income from the S corporation. Shareholders will then use the Schedule K-1 to file their individual tax returns, or Form 1040.
S Corporation Shareholders Taxation
The owners of an S corp face tax rates that are similar to the rates paid by individual wage earners of a company, similar to all pass-through owners. But, the amount the owners pay in taxes depends on their involvement with the company. The difference in the rates that types of owners pay is determined by how the ACA Net Investment Income Tax and the payroll tax, which pays for Medicare and contributes to Social Security impacts the owners. Active shareholders will be receiving a wage income and profit shares from the S corp. Their wage income will be subject to payroll tax, meaning when filing their tax return they will have already paid into Medicare and Social Security. Passive shareholders will not receive a wage income, and will therefore not be paying into Medicare and Social Security. This increases their tax rate on profit shares from the S corp. As such, shareholders who are passive may face top marginal tax rates that are higher than those of active shareholders.
Special Tax Deduction for S Corp Owners
As is the case with other pass-through businesses, S corp owners may be eligible to take a Qualified Business Income Deduction, which will allow them to deduct up to 20% of their income with certain qualifications. This QBI is taken based on the owners tax return, not the S corp tax return.
Are S Corps Taxed Twice?
Double taxation can be an issue with corporations due to the fact that the net income of the business will be taxed and the shareholders will be taxed on their dividends. Since the income tax is paid through the owners personal tax return in an S corp, there are no taxes imposed on the corporation and no dividends paid so this problem is avoided.
How Are S Corp Distributions Taxed?
When income is earned by an S corp it will only be taxed once, whether it is distributed or invested. The owners will pay regular income tax on the distributions they receive, but no self-employment tax will be paid on the distribution. Different types of distributions have unique tax implications, and several attributes are required to determine the taxability and type of distribution. This can be complicated, so it is worth speaking to a professional to avoid any tax issues with S corp distributions.
S Corporations and State Taxes
S corporations are required to pay state taxes for the state or states they operate in, similar to most other corporations. They will be required to pay state sales tax and excise taxes, which is a tax used on the consumption of goods such as gasoline or alcohol, in the same manner as other business types who are operating in the state. Some states will levy franchise taxes, state income taxes or other gross receipts on S corporations. The taxes paid will be dependent on the state in which your S corp operates, as well as any other states you may do business in. It is important to determine what the tax requirements are in your state to ensure tax compliance.
Other Taxes Paid by S Corporations
S corporations will also pay employment taxes on employee pay, including withholding and reporting federal and state income taxes, paying into and reporting FICA taxes, which covers Social Security and Medicare, workers compensation taxes and unemployment taxes. These are customary taxes that all employers must contribute to each year. If an S corp owns any property, property taxes are also to be paid on the property by the corporation.
S Corp Tax Questions? Evolution Tax and Legal Can Help
Ensuring tax compliance for your corporation can be complicated – but our team of dually-certified CPAs and business formation attorneys in Orange County has the expertise and knowledge to make your corporation’s tax season simplified. Contact the team today to learn more about how we can help with your S corp taxes.