An S corp is a pass-through entity, which means the corporation itself does NOT pay income tax. Instead, you (the owner/shareholder) report the company’s income on your personal tax return.
Here’s exactly how it works:
1. The S Corp Files a Tax Return — Form 1120-S
- Your S corp must file Form 1120-S with the IRS.
- This form reports the company’s total income, expenses, and net profit for the year.
2. You Receive a Schedule K-1
- The S corp prepares a Schedule K-1 (Form 1120-S) for each shareholder.
- The K-1 shows your share of the company’s profit or loss (even if the company didn’t distribute cash to you).
- This includes:
- Ordinary business income
- Dividends
- Interest
- Rental income
- Other pass-through income items
3. You Report the K-1 on Your Personal Tax Return
- You report the income from the K-1 on your Form 1040, usually on Schedule E.
- You pay personal income tax (federal and possibly state) based on your total share of profit — not just what you withdraw.
- The income is taxed at your individual tax rate.
4. You Pay Self-Employment Tax Only on Your W-2 Salary
- As an owner-employee, you must pay yourself a reasonable salary via payroll.
- This salary is subject to:
- Payroll taxes (Social Security & Medicare)
- Federal and state income tax withholding
- This is different from business profit: K-1 profit is NOT subject to self-employment tax — that’s one of the main tax benefits of an S corp.
Example:
Let’s say your S corp made $150,000 profit this year.
- You paid yourself a salary of $60,000 (via payroll).
- You left the remaining $90,000 as retained earnings in the business.
Here’s how taxes work:
- You pay payroll taxes (Social Security, Medicare, and income tax) on the $60,000 salary.
- You pay income tax only (no payroll/self-employment tax) on the $90,000 K-1 profit, reported on your personal tax return.
Summary Table:
| Income Type | Taxed As | Where It Goes |
|---|---|---|
| W-2 Salary | Income + payroll taxes | Form W-2 + Form 1040 |
| K-1 Business Profit | Income tax only | Schedule K-1 → 1040 |
Pro Tips:
- Make sure your salary is “reasonable” — not too low to avoid payroll taxes.
- You may need to make estimated tax payments quarterly for the income passed through on the K-1.
- Work with a CPA to handle payroll, tax filings, and to ensure compliance.