Personal Taxes and S Corporations: What You Need to Know
Although it operates as a corporation, S corporations are considered hybrid entities—a combination of a partnership and a corporation. This classification means that it has its own taxation setup.
If you want to avoid double taxation, you should familiarize yourself with how taxation works for S corporations and whether the people involved need to file for personal income taxes.
What Is an S Corporation?
An S corporation is a small business entity formed in the same way as any other corporation. But to be considered an S corporation, it has to meet certain requirements:
It must have no more than 100 shareholders
Each shareholder can only own one share of stock
It must be a domestic corporation
All shareholders must be natural persons—they cannot be owned by another corporation, trust, or partnership
How Do Taxes Work for S Corporations?
Being a hybrid entity, S corporations are afforded certain advantages, so understanding how they work is important when it comes to taxation.
It should first be noted that although S corporations are considered corporations, they are still required to pay taxes on their income as if they were a sole proprietorship or partnership.
As an S corporation owner, you do not have to report your personal earnings. However, you may have to pay taxes on any income the corporation earns if you are a salaried employee.
What Do Annual Business Tax Returns Look Like for S Corporations?
An S corporation's tax return is a bit different from that of a C corporation. Therefore, you should not compare the two.
Annual tax returns for S corporations are called the Form 1120S, and S corporations use the calendar year as their tax year. Form 1120S is used solely for informational purposes—it helps the IRS have an idea about how the business is earning and the expenses the business has.
Aside from this, the S corporation is also expected to submit a K-1 form for every shareholder. Here, every shareholder will report their share of earnings and deductions from the corporation income.
What Do Shareholder Tax Returns Look Like for S Corporations?
Shareholders of S corporations are not obligated to file for personal income taxes if the S corporation does not pay any wages. If the S corporation does pay wages, then the shareholders must file annual tax returns using form 1040, schedule E.
If you would like to remain tax-free as an S corporation shareholder, it is important to ensure that you do not receive any compensation. If you do, then you will not be able to avoid paying taxes on your personal income.
Final Thoughts
As mentioned above, taxes are complicated, and this is even more so for S corporations given their unique classification as a partnership and corporation. That being said, there are a lot of things to take into account when filing taxes for an S corporation, including the shareholder's share of income and losses, as well as any distributions, made to shareholders.
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