How Do S-corporations work?

Most corporations can make a special election to be treated as an "S-corporation" for Federal income tax purposes.

An S-corporation differs from a regular corporation in the following ways:

  1. An S-corporation does not generally pay an entity-level tax. Instead, it passes through the income and other reportable items to its shareholders on Schedule K-1, and they include it on their personal returns.

  2. While the above is similar to the way a partnership works, two important distinctions: An S-corporation has the limited liability protection that is offered by the corporate form. Also, net pass- through earnings from an S-corporation are not subject to self-employment tax.
    Note: Despite a popular misconception, you CANNOT avoid FICA or SE tax by forming an S-corporation. You are still required to draw a salary, subject to payroll taxes, that is reasonable for the value of the services you provide to the corporation.
  3. Unlike a regular corporation, shareholder-employees of an S-corporation cannot receive tax-free employee benefits (except a pension). Any medical insurance, life insurance, etc. must be charged to the shareholder-employee as additional wages.

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