Understanding S Corp Taxes

S Corps taxes have some of the most unique tax advantages available to small businesses and their shareholders. In short, an S Corp is a designation that the IRS provides to small businesses under Subchapter S of the Internal Revenue Code that can lead to some pretty significant tax savings when compared to other business structures.

Overall, S Corps, their operation, structure, tax implications, and their requirements and responsibilities that must be met are a doozy, so let us guide you through this topic in as clear and complete a manner as possible.

Whether you’re considering forming an S Corp to take advantage of the benefits they offer, or just looking to do better with your existing S Corp, this article is what you need. We will also give you some very useful tips to lower an S Corp tax liability, so scroll down if you’re looking for those. Let’s begin!

What Is An S Corp?

Perhaps the most succinct way to describe an S Corp is as a business structure, one that allows companies to pass corporate income, losses, deductions, and credits straight to its shareholders for federal tax purposes. Why go that route? Well, to avoid the “double taxation issue” that’s commonly associated with more traditional C Corporation structures (more on that later).

The name “S Corp” itself comes from Subchapter S of the Internal Revenue Code. In practice, S Corps operate like standard corporations when it comes to organization and liability protection but differ greatly when it comes to taxes. Let’s take a look at how and why.

S Corp Taxes

S Corps are considered pass-through entities, a term meaning the company itself doesn’t pay any federal income taxes; instead the profits and losses are passed through to shareholders , who report them on their individual tax returns. Sounds like a sweet deal, right?

That’s because this structure essentially skips over the problem of double taxation that C Corporations face, where income is taxed at both the corporate and shareholder levels.

Here are the key features of how S Corps are taxed: 

• Pass-Through Taxation: Corporate income is taxed only at the individual level; the business itself does not get taxed on its profit.
• Tax Benefits: Shareholders may avoid self-employment taxes on certain income (though not 100% of it).
• Tax Exemptions: Generally speaking, S Corps are generally exempt from federal corporate income taxes.

S Corp Income Taxes

There are specific tax filing requirements and deadlines that S Corps must follow each year. They are as follows: 

• Annual Tax Returns: S Corps must use Form 1120-S, which must be filed by March 15th (instead of April 15th) or the 15th day of the third month after the end of the tax year.
• Quarterly Payroll Tax Returns: Employers must file Form 941 quarterly to report any withholdings for Social Security, Medicare, and federal income tax.
• Unemployment Tax Filings: Federal Unemployment Tax (FUTA) returns are due annually by January 31st.

As you can imagine, there are also specific penalties that S Corps can face if they fail to comply with the requirements listed above (and some others described in Subchapter S). They are the following:

• A late filing of Form 1120-S will result in a penalty of $210 per month, per shareholder.
• Other penalties may apply for failing to file payroll taxes or other required forms.

Finally, it’s time to expand on perhaps the most interesting (and attractive, honestly) characteristic of an S Corporation: Tax exemptions. That’s right, S Corps are exempt from federal corporate income taxes (except in certain cases like passive income exceeding 25% of gross receipts).

How Are S Corps Taxed?

We’ve mentioned it before but it bears repeating: S Corps afford owners and shareholders several tax advantages that are worth considering.

• Tax Rates: Shareholders pay income tax on their share of the company’s profits at their individual tax rate (this can go from 10% to 37%).
• Self-Employment Taxes: When it comes to distribution, shareholders’ income is not subject to self-employment taxes, unlike income from sole proprietorships or partnerships.

Let’s look at an example: A shareholder receiving a reasonable salary (plus additional distributions) will only pay payroll taxes on the salary portion, reducing their overall tax burden.

S Corp vs. LLC

While S Corps and LLCs are similar in a myriad of ways, they also differ significantly in key points such as taxation and structure: 

• Taxation: S Corps are pass-through entities, which means they don’t pay federal income tax at the corporate level as we’ve mentioned before, and allows for shareholders to save on self-employment taxes. On the contrary, LLC members must pay self-employment taxes on all their earnings.
• Ownership: S Corps actually have much stricter shareholder requirements, while LLCs offer more flexibility.
• Management: While S Corps operate as regular corporations with officers and directors, LLCs have a member-drive structure that’s much simpler.

Should You Choose An S Corp?

There are several factors you should consider before choosing to set up an S Corp, but in general, those looking to minimize self-employment taxes as a main priority should definitely consider an S Corp as their best bet. Those who are looking for a business structure that’s more flexible for its owners and has fewer operating restrictions, LLCs might be the way to go.

Setting Up An S Corp: What You Need To Know

There are several steps to forming an S Corporation, and we strongly recommend that you get all the help you can get from financial professionals before undertaking this project, but generally speaking, these are the steps you have to take:

• Incorporate the business. File Articles of Incorporation with your state.
•  Apply for an EIN: You must obtain an Employer Identification Number (EIN) from the IRS.
• Choose the S Corp status: To get S Corp status from the IRS, you must file Form 2553 with them within 75 days of incorporating or the start of the tax year.
• Maintain Compliance: Closely adhere to state and federal requirements in order to keep your S Corp status beyond the first year, such as holding annual meetings and maintaining records. Failure to do so can bring about the removal of S Corp status from your business.

How Can S Corporations Reduce Their Taxes?

There are actually several ways an S Corp can lower their tax burden in a perfectly legal and easy manner. Just remember that these tips can always have a financial advisor helping you implement them in a way that maximizes their benefits to you.

Pay Reasonable Salaries

Any shareholders who are also working the day-to-day operations of the business should remember to pay themselves a reasonable enough salary to comply with IRS requirements. After all, you’re still running a business!

It’s necessary to balance the salary and distributions from said business, because salaries are subject to payroll taxes while distributions are not; this allows shareholders to minimize their overall tax liability while still playing by the IRS’s rules.

Maximize Deductions

Running a business comes with a plethora of legitimate business expenses that you can deduct to significantly lower your taxes. Anything from office supplies, business trips, and utilities, all the way to health insurance premiums are allowed.

Just remember to keep thorough documentation supporting each of these deductions to ensure compliance with IRS rules and to have evidence in your favor in case of a tax audit.

Contribute to Retirement Plans

By establishing and contributing to retirement accounts (like IRAs or 401(k)) plans, you’d not only be reducing your taxable income as a shareholder, it would also help attract and (more importantly) retain talented employees. As deductibles, employer contributions provide a dual benefit to both the business and its workforce.

Utilize the QBI Deduction

The Qualified Business Income (QBI) deduction allows eligible S Corps to deduct up to a whopping 20% of their business income. It goes without saying that this could result in substantial tax savings, especially in the service industry.

Keep in mind, however, that the deduction itself is subject to income thresholds and other limitations, so this is the type of situation why we recommend having a financial advisor at the ready for.

Hire Members Of You Family

Keeping it all in the family can actually help you keep taxes low. By employing family members, you’re shifting the income to individuals who are in lower tax brackets. For example, by hiring a minor to perform legitimate work at the business can actually reduce the tax liability for the whole family.

Just remember to actually pay proper, reasonable wages that are in line with the work they’re performing, and to keep proper payroll documentation through their whole employment.

IRS Requirements for an S Corp

Thinking of creating an S Corp yourself? Well, then you want to pay attention to the following requirements that, per IRS rules, every business want to do the same must meet.

1. Corporation status: Be a domestic corporation.
2. Shareholder limit: Have no more than 100 shareholders.
3. Shareholder status: Shareholders must be legal U.S. citizens or resident aliens; certain trusts and estates are also allowed as shareholders.
4. Stocks: The business itself is only allowed to issue one class of stock.

As for the eligibility of shareholders, the following are considered ineligible by the IRS: Partnerships, corporations, and non-resident aliens are not allowed to be shareholders in an S Corp.

S-Corp Taxes: FAQ

1. What is an S Corp?
An S Corp is a business structure that allows profits, losses, and tax credits to pass through to shareholders’ personal tax returns, avoiding double taxation. On top of that, S Corps do not pay federal income taxes at the corporate level as C Corporations do.

2. How are S Corps taxed?
S Corps are taxed as pass-through entities: The corporation itself does not pay federal income taxes; it is shareholders who report their share of profits on their individual tax returns and pay taxes at their personal income tax rates (covering the full spectrum from 10% to 37% as of 2025).

3. What are the filing requirements for S Corps?
S Corps must file Form 1120-S annually to report income, deductions, and shareholder distributions. They are also responsible for filing payroll tax returns (Form 941) quarterly and unemployment tax filings annually. Failing to meet these deadlines can result in substantial penalties.

4. Can an LLC elect to be taxed as an S Corp?
Yes, an LLC can elect S Corp status by filing Form 2553 with the IRS, provided it meets the eligibility criteria. By choosing to be taxed as an S Corp, the LLC get the benefits associated with S Corp taxation such as reduced self-employment taxes, all the while maintaining the flexibility of its management structure.

5. What are the benefits of an S Corp? S Corps offer tax savings through pass-through taxation, reduced self-employment taxes, and eligibility for the Qualified Business Income deduction. Additionally, its shareholders will benefits from limited liability protection which makes it an incredibly attractive option for small businesses in general.

6. Are there any downsides to an S Corp? Yes, S Corps have stricter eligibility requirements, more administrative responsibilities, and limits on the number and type of shareholders (100 is the maximum allowed by the IRS). An S Corp demands a more involved style of management and administrative responsibilities, which includes mandatory tax filings and a strict compliance with corporate formalities, thus increasing operating costs.

Jacob Dayan

Entrepreneur • SEO Community Tax, LLC

Jacob Dayan is the CEO and co-founder of Community Tax LLC, a leading tax resolution company known for its exceptional customer service and industry recognition. With a Bachelor’s degree in Business Administration from the University of Michigan’s Ross School of Business, Jacob began his career as a financial analyst and trader at Bear Stearns and Millennium Partners before transitioning to entrepreneurship. Since 2010, he has led Community Tax, assembling a team of skilled attorneys, CPAs, and enrolled agents to assist individuals and businesses with tax resolution, preparation, bookkeeping, and accounting. A licensed attorney in Illinois and Magna Cum Laude graduate of Mitchell Hamline School of Law, Jacob is dedicated to helping clients navigate complex financial and legal challenges.

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