S Corporations

An S corporation that makes, say, $100,000 in profits pays no income taxes on that profit. Instead, the shareholders of the S corporation include the profit on their returns. If two shareholders equally own an S corporation that makes $100,000, for example, each shareholder adds $50,000 of income to his or her return and then pays the tax on that $50,000 profit from the S Corporation. Two quick final comments about choosing to operate as an S corporation: First, just to be clear on this point, small business owners use S corporations to minimize the amount they pay in payroll taxes. The S corporation minimizes amounts shareholder-employees pay in payroll taxes because the S corporation profit allocated to a shareholder isn't subject to payroll taxes. And now a second comment: The catch with an S corporation is that the salary you set for a shareholder-employer such as the owner needs to be reasonable. A low salary might save payroll taxes temporarily, but the IRS should be able to successfully challenge such a salary. The 1120S tax return, which is what an S corporation files, makes it very easy to see when shareholder-employees are under-compensating themselves.