Tax Paid by a Self-Employed S-Corporation

by Dan Keen

Protecting personal assets from exposure to a person’s business activities is one reason why single owners and partners often choose an “S” Corporation as their legal business structure. The S Corporation is considered to be a legal entity unto itself, and thus it isolates the owner or owners from being personally responsible for any debts or lawsuits incurred by the company. In addition, there can be tax advantages to being an S Corporation, though owners may be responsible for paying self-employment taxes.

Profits and Losses are “Passed Through”

Generally, the S Corporation itself pays no taxes (the exceptions are on certain built-in gains and passive income). All profit and losses are passed through directly to the owners, who are called “shareholders”. Each individual shareholder, therefore, is responsible for reporting the amount of money received from the company, and he must file and pay taxes on that income.

Shareholder Filing Requirements

When a shareholder takes profit from the S Corporation as a distribution, the company does not withhold any money for taxes, such as Social Security, Medicare and Federal Unemployment Tax (FUTA), as it would to those employees who receive a salary. Therefore, the shareholder is responsible for paying self-employment tax. She must also file quarterly estimated taxes by sending a check and Form 1040-ES, “Estimated Tax for Individuals,” to the Internal Revenue Service. At tax time, she would file a Schedule E, “Supplemental Income or Loss,” with her Form 1040, and fill out Part II, “Income or Loss from a Partnership or S Corporation”.

S Corporation Filing Requirements

Even though the S Corporation may not pay any taxes, the company must file Form 1120S at tax time. It must also send a Schedule K-1 to each person who received money from the company so they can report it as income. If there are employees, the company must also file any appropriate forms necessary, such as Form 941, “Employer’s Quarterly Federal Tax Return,” and Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return.”

Saving Taxes Through an S Corporation

Owners of S Corporations can save on self-employment or Social Security/Medicare taxes by splitting the profits taken from the company into two types of payments, salary and S Corporation distributions. While the shareholder must pay Social Security/Medicare tax on the money paid to him as a salary, there is no such tax on distributed money. Another tax advantage is that any business losses are passed through to the owners, who can take these deductions on their personal income tax returns. It is typical for new businesses to operate at a loss the first year or two in business, and these loss deductions can save money on an individual’s federal and state income taxes.

About the Author

Dan Keen is the publisher and editor of a county newspaper in New Jersey. For over 30 years he has written books and magazine articles for such publishers as McGraw-Hill. Keen holds a degree in electronics, was chief engineer for two radio stations and taught computer science at Stockton State College.

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