Understanding S corporation tax rules

Businesses of almost any size can qualify to operate as a corporation in Texas. However, smaller companies may benefit from operating as an S corporation instead of a traditional C corporation. While the S corporation structure does provide an owner with limited liability, it is taxed differently than a traditional corporation would.

A pass-through entity

An S corporation is considered a pass-through entity as the company’s profits and losses flow from the corporation to an owner’s tax return. The profits and losses will be split among the entire group if your company has multiple owners. This means the earnings are only taxed once, bypassing state or federal corporate taxes. Profits and losses for each shareholder are reported on a Schedule K-1 form.

The owner’s draw

One of the key benefits of operating as an S corporation is that you don’t have to pay FICA taxes on all of your earnings. Instead, you can divide earnings into a formal salary and an owner’s draw. The owner’s draw is a distribution of any remaining profits after paying yourself and accounting for other expenses. This distribution is taxed as ordinary income as opposed to wage income. However, as a matter of tax law, it is important to pay yourself a competitive salary as the IRS has the power to reclassify any payments made to yourself throughout the year.

As a business owner, it’s important to understand how a company is taxed and when payments must be made. Typically, corporate tax returns are due on March 15 instead of April 15, with extensions available if needed. Failing to file or pay taxes as they come due could result in penalties and interest accruing until the outstanding balance is paid in full.