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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:
- 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.
- 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.
- 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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