What is S corporation tax treatment?

S corporation tax treatment allows a corporation to pass income, losses, deductions, and credits through to shareholders for federal tax purposes. The corporation itself generally pays no federal income tax. Instead, shareholders report their share of income on personal returns and pay tax at individual rates. This avoids the double taxation that applies to C corporations.

The payroll tax savings opportunity

S corporation shareholders who work in the business must take reasonable compensation as salary, subject to payroll taxes. Remaining profits distributed as dividends avoid payroll tax. If you earn $200,000 and take $100,000 as salary and $100,000 as distributions, you save roughly $15,000 in self-employment tax compared to a sole proprietorship. The IRS scrutinizes unreasonably low salaries.

When S corp election makes sense

Consider S corporation status when profits consistently exceed what reasonable compensation would be, typically above $60,000 to $80,000 in net income. Below that threshold, payroll tax savings rarely justify the added compliance costs of payroll, separate returns, and corporate formalities. Run the numbers with your tax advisor before electing.