There are two types of corporations in the eyes of the IRS: C corps and S corps. An S corporation is like a version of a C corp yet features investment opportunities, perpetual existence, as well as limited liability protection.
S corps only have to file taxes annually and they are not subject to double taxation like C corps. However, there are also a few disadvantages to S corps.
How do you file taxes for an S corporation? What are the tax rules and how are they treated differently by the IRS? Let’s examine in more detail.
What is an S Corporation?
An S corp is a special kind of corporation that operates as a corporation, yet is taxed on the individual shareholders’ tax forms. As a result, S corporations are comparable to sole proprietorships and partnerships, which are considered “pass-through” entities.
This is different from C corporations, which are subject to double taxation. What that means is a C corp is taxed first as a business, then individual shareholders must also file for profits or losses from the business on their personal returns.
Meanwhile, with an S corp, there is no need to cover the double taxation as the pass-through income is taxed only on the shareholders’ personal tax forms. There is no need to pay corporate tax as well.
It may sound like common sense to file as an S corp as opposed to a C corp to avoid double taxation, however, it is not that simple.
Steps to File S Corporation Taxes
S corporations are “pass-through” entities like sole proprietorships and partnerships. There is no double taxation because the company itself is not taxed, just the individual shareholder(s).
In other ways, filing taxes for an S corp is like any other corporation:
● The first step is to file a Form 1120-S for your corporation.
● Each shareholder’s share of the profit or loss from the corporation needs to get reported on a Schedule K-1.
● The information reported on Schedule K-1 is then reported on each shareholder’s Line 17 of their individual Form 1040.
Does the process differ for state taxes? Most states use federal information to determine total income for state tax purposes. If you are unsure, it is a good idea to check with your local state government or contact a tax professional.
Income Taxes & S Corporations
Even though S corps get to bypass double taxation, they do get penalized in another way: income tax.
The owners of a corporation are shareholders and they receive dividends as a return on their investment. As a result, S corps have owners that pay regular income tax on the distribution of dividends. However, they are not considered self-employed, so no self-employment tax is assessed on the distribution.
Additionally, S corps pay other taxes like regular businesses, including employment taxes, worker’s compensation taxes, and unemployment taxes. Owners also pay taxes on the property of their business.
S corporations must also pay state sales taxes and excise taxes. If you are unsure of anything regarding state or local government taxes, it is a good idea to check with your state’s department of revenue.
You also need to make yourself aware of states that levy franchise taxes, state income taxes, or gross receipts taxes on S corps.
Other Warnings for S Corporations
Though there are plenty of advantages to creating an S corp compared to a C corp, you should also make yourself aware of the following:
● S corps are only open to U.S. citizens and permanent residents, unlike C corps.
● There is limited ownership. Consequently, S corps may not have more than 100 shareholders.
● You can potentially lose your S corp status if you make mistakes while filing, even if the mistakes were made accidentally.
● The IRS tends to scrutinize S corps more because payments to employees and shareholders can get distributed as salaries or dividends. Each is taxed differently, which is why the IRS tends to study S corps in greater detail.
Levy & Associates Commitment to S Corporations
S corporations have a distinct advantage over C corps because there is no double taxation. However, some limitations do apply to an S corp. You also need to make sure you file taxes correctly in order to avoid losing S corp status.
Contact Levy & Associates to learn more about how we can help you file taxes for your S corp. We have assisted corporations for over two decades and know what it takes to keep you on the right side of the IRS. We are available for free, no-commitment initial consultations. Call us at 800-TAX-LEVY, or visit www.levytaxhelp.com.