An S corporation (S corp) is a special tax designation available to certain eligible businesses in the United States. Rather than being a separate type of business entity, an S corp is a tax election that can be applied to entities such as corporations or limited liability companies (LLCs).
The key benefit of an S corp is that it allows business income, losses, deductions, and credits to pass through to the owners’ personal income tax returns, avoiding double taxation.
What Is an S Corporation?
An S corporation is a business that has elected to be taxed under Subchapter S of the Internal Revenue Code.
Key characteristics:
- Must be a domestic entity
- Limited to 100 shareholders
- Shareholders must generally be individuals (not corporations or partnerships) and U.S. citizens or residents
- Can issue only one class of stock
How S Corps Are Taxed
Unlike traditional C corporations, S corporations do not pay federal income tax at the business level (with a few exceptions). Instead:
- The S corp files an informational tax return (Form 1120-S)
- Profits and losses are passed through to shareholders
- Each shareholder receives a Schedule K-1 (Form 1120-S)
How S Corps Affect Individual Income Taxes
1. Pass-Through Income
Each shareholder reports their share of the company’s income on their personal tax return (Form 1040), regardless of whether the income is actually distributed.
Example: If you own 50% of an S corp that earns $100,000, you report $50,000 on your personal return.
2. Income Is Taxed Once
This is one of the biggest advantages:
- C corporation: Income is taxed at the corporate level and again when distributed as dividends
- S corporation: Income is only taxed at the individual level
3. Shareholder Compensation
If you work for your S corp, you must be paid reasonable compensation, which is treated as wages and subject to payroll taxes.
There are two types of income:
- Wages (salary):
- Subject to Social Security and Medicare taxes
- Reported on Form W-2
- Distributions (profits):
- Not subject to self-employment tax
- Still taxed as income
4. Self-Employment Taxes
One advantage of an S corp is:
- Only salary is subject to payroll taxes
- Remaining profits distributed to shareholders are not subject to self-employment tax
This can result in tax savings compared to sole proprietorships or partnerships.
5. Deductions and Losses
Shareholders can potentially deduct business losses on their personal return, subject to certain limitations:
- Basis limitations (how much you’ve invested)
- At-risk rules
- Passive activity loss rules
6. Qualified Business Income (QBI) Deduction
S corp shareholders may qualify for the Section 199A deduction, which allows up to a 20% deduction on qualified business income, depending on income level and business type.
How to Report S Corporation Income on Your Tax Return
As an S corporation shareholder, the forms you use depend on the type of income you receive from the business.
Schedule K-1 Income
The S corporation reports your share of income, deductions, credits, and other tax items on Schedule K-1 (Form 1120-S). You must report these amounts on your individual tax return, even if the income was not distributed to you.
Depending on the type of income reported on your Schedule K-1, the information may flow to:
- Form 1040, Schedule E (Supplemental Income and Loss) – Used to report ordinary business income or loss from the S corporation.
- Schedule D (Capital Gains and Losses) and Form 8949 – Used to report capital gains and losses passed through from the S corporation.
- Other schedules and forms as applicable for interest, dividends, credits, or deductions reported on the K-1.
Wages Paid by the S Corporation
If you work for the S corporation and receive a salary, your wages are reported on Form W-2 and entered on Form 1040, Line 1a (Wages, salaries, tips, etc.). These wages are subject to Social Security and Medicare taxes.
Distributions
S corporation distributions are generally not reported separately as taxable income unless they exceed your stock basis or are otherwise taxable under IRS rules. Most distributions are reflected through the shareholder's basis calculations, while the income itself is reported through Schedule K-1.
Do I Use Schedule C for an S Corp?
No, Schedule C is used exclusively for sole proprietors and single-member LLCs.