When there’s extra income to distribute, shareholder-employees can receive dividends, which aren’t subject to FICA taxes. S corporation shareholder-employees must collect a salary, which is subject to FICA taxes. Owners usually pay both halves of FICA on the entire portion of pass-through earnings, but that's not the case for S corporation shareholder-employees. Pass-through entity owners are usually considered self-employed, meaning they pay the employee and employer portions of Federal Insurance Contributions Act (FICA) taxes, totaling 15.3% of gross wages. Others hear “payroll tax savings” ringing in their heads. To the untrained ear, employee classification might seem insignificant. Unlike other pass-through entity types, S corporation shareholders who actively participate in management can also be considered employees. Many LLC owners, called members, elect S corp status so they can be classified as employees of their organization. C corporation owners who prefer to reinvest earnings into the business can essentially eliminate the second layer of tax. It’s important to note that S corps don’t always triumph in the S corp vs. If an S corp has $100,000 in taxable income, all $100,000 gets taxed on the shareholders’ personal income tax returns. S corporations and other pass-through entities cut out the entity-level tax, passing all income tax liability to the owners, called shareholders. As the owner of a C corp, any income that makes it to your personal bank account gets taxed twice. You can see from this example that cash dividends, called shareholder distributions, are essentially taxed twice. The shareholder pays income tax on the $79,000 dividend when he or she files personal tax Form 1040. Shareholder-level tax: The C corporation declares all $79,000 in cash dividends to its 100% shareholder.Entity-level tax: The entity pays a 21% corporate income tax on a net income of $79,000 ($100,000 taxable income = $21,000 corporate income tax).
Say a C corporation with one shareholder has taxable income of $100,000. One of the hallmarks of S corporations is taxation only at the shareholder level. No double taxationĬ corporations, known as traditional corporations, pay income tax at the entity and shareholder levels. Chief among the perks are double taxation avoidance, shareholder-employee status, and limited liability. S corporation status offers a plethora of advantages over other business types. Check out all the eligibility requirements in The Blueprint’s guide to S corporations.ģ tax benefits of filing as an S corporation Not all C corporations and LLCs can take advantage of the S corporation tax status. From there, file IRS Form 2553 to elect S corporation taxation.
To get S corporation tax treatment, register your business as a C corporation or limited liability company (LLC). Instead, S corporations enjoy pass-through taxation in which the company’s owners pay taxes on their portion of the company’s earnings based on their individual tax rates. S corporations don’t pay corporate income tax. But don’t demur S corp tax status: There are some great tax benefits you could be missing.ĭon’t let the word “corporation” confuse you. Many small business owners hesitate to elect S corporation taxation because it requires more upfront time to get going. It’s one of the most consequential decisions you’ll make when you first start your small business. Choosing a business structure requires a calculus that weighs tax and legal benefits with startup costs and time.
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