S-Corporation Tax Filing Guide

An S-Corporation (S-Corp) is a special tax designation that allows businesses to operate with the legal structure of a corporation while enjoying pass-through taxation similar to a partnership. This hybrid structure combines liability protection with significant tax advantages, making it a popular choice for many small to mid-sized businesses.

Eligibility: Who Can Elect S-Corp Status?

Not all corporations qualify for S-Corp status. Strict requirements must be met:

Mandatory Qualifications:

• Must be a domestic corporation (U.S.-based)
• Have **100 or fewer shareholders** (spouses count as one shareholder)
• Shareholders must be **U.S. citizens or resident individuals** (with limited exceptions for certain trusts, estates, and tax-exempt organizations)
• Have **only one class of stock** (variations in voting rights are permitted, but not differences in distribution rights)
• Cannot be an ineligible corporation (e.g., certain financial institutions, insurance companies, or domestic international sales corporations)

Election Process:
- File **Form 2553, Election by a Small Business Corporation**
- Must be signed by **all shareholders** consenting to the election
- Strict **deadlines**:
 - Within 2 months and 15 days of the start of the tax year the election is to take effect, OR
 - Any time during the preceding tax year

We help determine if S-Corp status is optimal for your business and ensure proper, timely election.

Form 1120-S: The Core S-Corporation Tax Return

Unlike a sole proprietorship or partnership, an S-Corp must file its own annual tax return, even though it generally pays no federal income tax itself.

Form 1120-S, U.S. Income Tax Return for an S Corporation, serves as the informational return that reports the corporation's financial activity and allocates income, losses, deductions, and credits to shareholders.

What We Handle on Form 1120-S:

• Income & Expenses:** Reporting all business operations
• Balance Sheet: Schedule L detailing corporate assets and liabilities
• Reconciliation of Income: Schedule M-1 connecting book income to tax income
• Shareholder Allocation: The core function—calculating each shareholder's pro rata share of corporate items based on ownership percentage
• Tax Calculation:** Computing any potential corporate-level taxes (e.g., built-in gains tax, excess net passive income tax)
• The S-Corp itself **pays no federal income tax** on its profits (with a few exceptions). Instead, the tax obligation "passes through" to the shareholders.

Shareholder K-1s: The Personal Tax Connection

Schedule K-1 (Form 1120-S) is the critical document that connects the S-Corp to its shareholders' personal tax returns.

For Each Shareholder, We Prepare a K-1 Showing:

Their share of **ordinary business income or loss** (which flows to Schedule E of Form 1040)

Allocations of specific items like:

• Interest and dividend income
• Rental income
• Charitable contributions
• Section 179 expense deductions
• Credits (e.g., foreign tax credit)

Why K-1s Matter:
- Shareholders **report K-1 amounts on their personal Form 1040**, regardless of whether cash was distributed.
- Tax is paid at the shareholder's **individual income tax rates**.
- Shareholders may owe tax on S-Corp income they did not physically receive, known as **"phantom income."**

We ensure accurate K-1 preparation and educate shareholders on their personal reporting responsibilities.

Owner Salary Rules: Reasonable Compensation Requirement

This is the most critical compliance area for S-Corps. The IRS requires shareholder-employees who provide services to the corporation to receive **"reasonable compensation"** as wages subject to payroll taxes.

**The Rule:** You cannot avoid payroll taxes (FICA: Social Security & Medicare) by taking all profit as distributions.

Our Approach to Reasonable Compensation:

- We analyze roles, duties, hours worked, and **industry compensation data** to determine a defensible salary.
- We set up and manage **formal payroll** with proper withholding.
- We file all required **quarterly payroll tax returns (Form 941)** and **annual W-2s**.
- We help structure the remaining profits as **distributions**, which are not subject to self-employment tax.

Audit Risk: The IRS actively scrutinizes S-Corps paying little or no salary to working owners. Our proactive planning creates a defensible position.

Benefits of S-Corp Status

1. Pass-Through Taxation (Avoid Double Taxation)
- Business profits/losses pass to shareholders' personal returns.
- Avoids the **C-Corp double tax** (corporate tax + dividend tax).

2. Self-Employment Tax Savings
- Only **salaries/wages** are subject to FICA tax (15.3%).
- **Distributions** are not subject to self-employment or FICA tax.
- This can create significant savings compared to a sole proprietorship or partnership, where all net income is subject to self-employment tax.

3. Limited Liability Protection
- Shareholders' personal assets are generally protected from business debts and liabilities (similar to a C-Corp).

4. Professional Credibility & Perpetual Existence
- The corporate structure often enhances business credibility.
- The entity continues regardless of changes in ownership.

5. Favorable Inheritance & Gifting Rules
- S-Corp stock can be transferred without triggering termination of the election (within family members).

6. Qualified Business Income (QBI) Deduction Eligibility
- Most S-Corp shareholders qualify for the **20% pass-through deduction** (Section 199A) on their share of qualified business income, subject to limitations.

Let Us Optimize Your S-Corporation
Navigating S-Corp rules—from reasonable compensation to K-1 reporting—requires precision. We provide comprehensive tax filing, strategic salary planning, and ongoing advisory to ensure you maximize the benefits of S-Corp status while maintaining full IRS compliance. Contact us to discuss how an S-Corp can work for your business.