Building Your Business Becoming an Owner Business Types How an S Corporation Pays Taxes By Jean Murray Jean Murray Facebook Twitter Jean Murray, MBA, Ph.D., is an experienced business writer and teacher who has been writing for The Balance on U.S. business law and taxes since 2008. She has taught accounting, business law, and business finance at business and professional schools for over 35 years, has authored several books on saving money and simplifying your business, and was the owner of startup-focused company Emence Enterprises, LLC. learn about our editorial policies Updated on September 13, 2022 Fact checked by Vikki Velasquez Fact checked by Vikki Velasquez Vikki Velasquez is a freelance copyeditor and researcher with a degree in Gender Studies. Previously, she conducted in-depth research on social and economic issues such as housing, education, wealth inequality, and the historical legacy of Richmond VA as well as their intersectionality while working for a community leadership nonprofit. Vikki leverages her nonprofit experience to enhance the quality and accuracy of Dotdash's content. learn about our editorial policies Share Tweet Pin Email In This Article View All In This Article S Corporations Explained S Corporations and Income Taxes How S Corp Owners Pay Taxes Other Taxes Paid by S Corporations Photo: Chuck Savage / Getty Images You may have been advised that you could become an S corporation and save the "double taxation" problem of being a shareholder in a corporation. Yes, an S corporation is taxed in a different way from corporations, and the owners of an S corporation don't have the double taxation problem, but before you decide to elect S corporation status, you should understand how an S corporation pays income taxes. S Corporations Explained An S corporation (S corp) is a special kind of corporation which operates as a corporation but is taxed on the individual shareholders' tax forms, for federal income tax purposes. In order to become an S corporation, a business: must be a domestic corporationmust meet some specific requirements and thenmust file an election form with the IRS. S Corporations and Federal Income Taxes For tax purposes, an S corporation is considered a pass-through taxing mechanism. That is, the tax on the S corporation is passed through to the owners for federal income tax purposes. First, the corporation files a business tax return on Form 1120-S. Then each shareholder's share of the profit or loss of the corporation is recorded on a Schedule K-1. The K-1 information for each shareholder is reported on Schedule E of the person's individual income tax return. Note Most states use federal information to determine total income for state tax determination. How S Corporation Owners Are Taxed The owners of the S corp pay income taxes based on their distributive share of ownership, and these taxes are reported on their individual Form 1040. For example, if the profits of the S corp are $100,000 and there are four shareholders, each with a 1/4 share, each shareholder would pay taxes on $25,000 in profits. A Special Tax Deduction for S Corp Owners Like other pass-through businesses, S corporation owners may be eligible to take a Qualified Business Income Deduction (QBI) to deduct up to 20% of their business income (with certain qualifications). This deduction is in addition to the normal business expense deductions the S corporation can use to reduce its taxes. The QBI deduction is taken based off the owner's tax return, not the business' return. S Corps Avoid the Double Taxation Problem Double taxation is an issue with corporations, where the net income of the business is taxed and the shareholders are taxed on their dividends. In an S corp, the income tax is paid through the owners in their personal tax returns. No tax is imposed on the S corp, and there are no dividends. S Corporation Owners and Taxes The owners of an S corporation pay regular income tax on their distribution, but they are not considered to be self-employed, so they pay no self-employment tax on this distribution. If any of the owners also are employees, they receive a salary, from which FICA taxes (Social Security and Medicare tax) are withheld. Note Many S corp owners work in the business and some try to avoid taxes by not paying these people as employees. The IRS watches closely to make sure they receive reasonable compensation for their services, including paying Social Security and Medicare taxes on this income. Other Taxes Paid by S Corporations The S corporation pays the same taxes as other businesses, including: An S corporation must pay employment taxes on employee pay, including withholding and reporting federal and state income taxes, paying and reporting FICA (Social Security and Medicare) taxes, worker's compensation taxes, and unemployment taxes. Also, if the S corporation owns a building or other real property, property taxes are required to be paid on this property. S corporations are required to pay state sales taxes and excise taxes in the same manner as other business types. Check with your state department of revenue for more information on sales and excise taxes. Some states levy franchise taxes, state income taxes, or gross receipts taxes on S corporations each year. Check with your state department of revenue to see if your state requires these taxes. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning! Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. IRS. "S Corporations." IRS. "Qualified Business Income Deduction."