Tax glossary

S Corporation

S Corporation — what it means, how it works, and a real example, explained without the jargon.

What is S Corporation?

An S corporation is a corporation (or LLC) that elects to pass its income through to shareholders, sidestepping corporate-level tax.

How it works

Profits flow to owners via Schedule K-1 and are taxed on their personal returns. The catch: owners who work in the business must pay themselves a "reasonable" W-2 salary, and only that salary — not the remaining profit — is hit with payroll tax.

A quick example

An S corp earns $150,000. The owner takes a $90,000 salary (subject to payroll tax) and draws the other $60,000 as a distribution, which escapes the 15.3% self-employment tax.

What people get wrong

That payroll-tax savings is the whole appeal of an S corp — but "reasonable salary" is IRS-tested. Pay yourself too little to dodge tax and you're inviting reclassification and penalties.

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Frequently asked questions

What does S Corporation mean?

An S corporation is a corporation (or LLC) that elects to pass its income through to shareholders, sidestepping corporate-level tax.

How does S Corporation work?

Profits flow to owners via Schedule K-1 and are taxed on their personal returns. The catch: owners who work in the business must pay themselves a "reasonable" W-2 salary, and only that salary — not the remaining profit — is hit with payroll tax.

What's the most common mistake with s corporation?

That payroll-tax savings is the whole appeal of an S corp — but "reasonable salary" is IRS-tested. Pay yourself too little to dodge tax and you're inviting reclassification and penalties.