If you own a small business, you may have heard about S corporations. An S corporation, also known as a Subchapter S corporation, is a type of corporation that provides unique tax benefits for its shareholders. In this blog post, we’ll discuss the US taxation of S corporations and what you need to know.
What is an S Corporation?
An S corporation is a type of corporation that allows its shareholders to avoid paying corporate income tax. Instead, the corporation’s income, deductions, and credits flow through to the shareholders’ individual tax returns. This means that S corporations are considered “pass-through” entities.
S corporations are popular among small business owners because they offer the limited liability protection of a corporation while allowing the business to avoid paying double taxation, which is a common issue for C corporations. This makes S corporations an attractive option for small business owners who want to reduce their tax liability.
How is an S Corporation Taxed?
As mentioned earlier, an S corporation is a pass-through entity, which means that the business itself does not pay federal income taxes. Instead, the business’s income, deductions, and credits flow through to the shareholders’ individual tax returns.
When an S corporation makes a profit, the shareholders report their share of the profit on their individual tax returns. The amount of income that each shareholder reports is based on their percentage of ownership in the corporation. For example, if a shareholder owns 25% of the corporation, they would report 25% of the corporation’s income on their individual tax return.
One of the benefits of an S corporation is that the income is taxed at the shareholder’s individual income tax rate, which is usually lower than the corporate income tax rate. Additionally, the income is not subject to self-employment taxes, which is a tax that is often associated with sole proprietorships and partnerships.
What are the Requirements to be an S Corporation?
To qualify as an S corporation, a corporation must meet the following requirements:
- Be a domestic corporation
- Have only allowable shareholders, which are individuals, certain trusts, and estates and
- Have no more than 100 shareholders
- Have only one class of stock
- Not be an ineligible corporation, such as certain financial institutions or insurance companies
If a corporation meets these requirements, it can apply for S corporation status by filing Form 2553 with the IRS.
In conclusion, S corporations are a popular choice for small business owners who want to reduce their tax liability. By providing unique tax benefits, such as avoiding double taxation and self-employment taxes, S corporations can help business owners keep more of their hard-earned income.