What is S-Corporation?
An S-corporation is a US entity that elects pass-through taxation under Subchapter S. The corporation itself pays no federal income tax; profits flow to shareholders' personal returns. Limited to 100 shareholders, all US individuals (or certain trusts), and one class of stock. Owner-employees must pay 'reasonable compensation' as W-2 wages subject to FICA.
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Current Rate (Generally calendar year (fiscal year requires IRS approval))
Pass-through (owner pays personal income tax + FICA on W-2 portion)
Example
Acme Consulting Inc. (S-corp) earns $200,000 profit. The owner takes $80,000 W-2 salary (subject to FICA 7.65% employee + 7.65% employer = $12,240 FICA + income tax). Remaining $120,000 flows through as K-1 distribution — subject to income tax but NOT FICA. Tax saving vs. sole prop: ~$18,000.
How S-Corporation works in United States
S-corp election (Form 2553) is the most common tax strategy for profitable owner-managed businesses earning $80k+ annually. The election converts a portion of profit from SE-tax-bearing self-employment income into K-1 distributions exempt from FICA.
IRS requires shareholder-employees to receive 'reasonable compensation' — what someone would be paid for the same role at arm's length — before taking the rest as distributions. Under-paying salary to dodge FICA is the #1 S-corp audit issue.
Related terms
A C-corporation is a US business entity taxed separately from its owners under Subchapter C of the Internal Revenue Code. It pays 21% federal corporate income tax on profits, and shareholders pay personal tax on dividends — the 'double taxation' of C-corp profits. Most VC-backed startups are Delaware C-corps.
An LLC is a US business entity that combines limited liability with flexible tax treatment. Single-member LLCs default to disregarded entity status (taxed as sole proprietor on Schedule C). Multi-member LLCs default to partnership taxation (Form 1065). LLCs can elect S-corp or C-corp tax treatment via Form 8832/2553.
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