Filing S Corp Income Taxes

An S corp is a tax designation — governed by Subchapter S of the Internal Revenue Service (IRS) code — that allows a formal business (i.e., a corporation or a limited liability company) to elect to be treated as a hybrid form of pass-through tax entity.

The S corp tax designation allows a limited liability company (LLC) or corporation to pass its earnings and losses directly through to its shareholders. Therefore, LLCs and corporations that elect to be taxed as S corps are generally exempt from paying corporate income tax.

Instead, the owners of the S corp — its shareholders — are responsible for reporting and paying tax on their portion of the company’s income at the individual level. S corp owners receive compensation for their work in the company as a reasonable salary, with the remainder of the company’s profits allocated among shareholders as distributions from the firm.

S corps are a special kind of pass-through tax entity that combines the features of both partnerships and corporations. This tax designation also can provide an advantageous tax status for many business owners.

Like other pass-through entities, S corps pass their earnings directly to their shareholders and aren’t taxed on their profits at the company level.

However, unlike other pass-through entities where all of the business profits pass through to the owners as self-employment income, an S corp's profits and losses pass through to its owners in two different ways.

First, the IRS says that shareholders who also serve as directors, managers, or employees of an S corp must be paid fairly for their work. Consequently, shareholders in a S corp are legally required to pay themselves a salary or wages in exchange for their services to the corporation.

The IRS also says that S corp shareholders must pay themselves “reasonable compensation,” which the IRS defines as the value that would normally be paid for similar services by similar businesses in similar circumstances.

The remainder of an S corp’s profits are then treated as distributions, which the company allocates among its shareholders based on their ownership stake. Therefore, shareholders must pay income tax on their share of any salary or profits they receive rather than the S corp paying income tax at the company level.

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The term “pass-through taxation” refers to the practice of taxing business income and losses at the personal vs. corporate level. In pass-through entities, the profits and losses “pass through” to the company's owners.

S corps are a special type of pass-through entity. Just like other pass-through entities, the profits and losses of an S corp aren’t taxed at the corporate level but pass through to the shareholders.

Yet, unlike other pass-through entities, the profits of an S corp don’t flow directly to shareholders as self-employment income. Rather, the IRS requires S corp owners/employees to pay themselves a reasonable salary for the work they perform within the company with the remainder of the profits allocated to shareholders as distributions.

By combining aspects of both partnerships and corporations, the S corp tax designation provides a novel pass-through tax structure that can benefit many business owners. 

Even though S corps usually don’t have to pay federal income taxes, they typically must complete and file Form 1120S (US Income Tax Return for an S Corporation) with the IRS. An S corp uses this informational tax return to report its income, deductions, profits, and losses as well as how the company allocated them among its shareholders.

Along with its income tax return, an S corporation also must file Schedule K-1 (Shareholder’s Share of Income, Deductions, Credits, etc.) for each shareholder to report that individual’s allocation of the company’s income, deductions, credits, etc. to both the IRS and the shareholder.

But what if your S corp had no income? 

All corporations, including S corps, must file a tax return (Form 1120S) even if they had no income or expenses for the year

According to the IRS:

“A domestic corporation (including a Subchapter S corporation) must file an income tax return whether it has taxable income or not, unless it's exempt from filing under section 501.”

In addition to the IRS requiring S corps to file a tax return even if they had no activity for the year, there are several other reasons you should file a return for your S corp.

• Even if your S corp had no income, it may have had expenses. If your business had expenses but no income, you may be able to pass through those losses up to your basis in the company.
• Filing an initial tax return and then annual tax returns establishes a consistent paper trail and record of your S corp.
• Failing to file a tax return may put your business at higher risk of an audit and subject your company and shareholders to penalties and fines.

S corps must file a corporation income tax return (Form 1120S) together with any related forms and schedules (e.g., Schedule K-1) by the 15th day of the third month following the end of their fiscal year. For S corps that use the calendar year as their fiscal year, this is usually March 15 (or Sept. 15 with an extension).

Shareholders must file individual income tax returns (Form 1040), with their reported S corp income or loss, by April 15 unless that date falls on a holiday or a weekend. Alternatively, they can submit an application for an automatic extension to file along with payment of the estimated taxes due.

Because S corps must file a corporate tax return even if they have no activity in a given year, failing to file Form 1120S by the deadline can result in IRS penalties and fines for the company and its shareholders. 

These penalties can be steep. Failure to file a federal S corp tax return on Form 1120S — or failing to provide complete information on the return — carries a penalty of $210 per shareholder per month for up to 12 months.

To avoid a penalty, you should file for an extension. You can automatically obtain a six-month filing extension by filing Form 7004. It's important to remember that in order to get the additional six months, you must file Form 7004 before the initial due date of the return.

In addition to income taxes, S corps also have several other tax responsibilities. These include payroll taxes and the Federal Unemployment Tax Act (FUTA) taxes.

The IRS requires all employers to collect, report, and remit federal payroll taxes from their employees' paychecks. Payroll taxes include personal federal income taxes that are withheld from employee pay as well as Social Security and Medicare taxes.

Employers must report and pay these payroll taxes to the IRS quarterly, using Form 941 (Employer’s Quarterly Federal Tax Return). However, some companies may need to make payroll tax payments more frequently. 

S corps can file Form 941 by mail, by using an IRS-approved software provider, or by hiring a professional accountant equipped to prepare and efile employer quarterly tax returns.

When and how often you pay your payroll taxes will depend on how large your payroll was during the previous period. Based on the size of your S corp’s payroll, the IRS may require you to make payroll tax payments quarterly, monthly, or biweekly.

The Federal Unemployment Tax Act (FUTA) requires that all employers pay into the federal unemployment system, which is part of a larger system to fund federal unemployment programs and state unemployment benefits.

Employers can use Form 940 (Employer’s Annual Federal Unemployment Tax Return) to file their federal unemployment taxes. In most cases, they must file and pay federal unemployment taxes on a quarterly basis. The IRS may permit some small employers to make their FUTA tax payments less frequently. 

You’ll also need to check with your state because most states also have their own unemployment taxes that employers need to pay.

Recommended: S corp taxes can be challenging. Book a free consultation with a professional accountant to ensure your taxes are filed correctly.