Paying S Corporation taxes can be a bit complicated since you’re both an employee and a shareholder. Your requirements are really the same as any other business owner though.
Here are some best practices when dealing with S Corporation taxes.
Shareholder vs Employee
As an employee of an S Corp, your taxes are taken care of through withholding. Woo, that’s a relief!
As a shareholder of an S Corp, you will pay taxes based on the profits of the business, not the actual money you withdraw from the company. So essentially you are responsible for the taxes of the S Corporation. That means we need to dig a little deeper.
S Corporations are flow-through entities that pay no tax at the business level (unless more complex issues exist like capital gains).
Think of it like a river. The business is upstream, and the shareholders are downstream. All of the profits of the business flow downstream to the shareholders. The taxes are then paid at the personal level. This allows S Corporations to avoid the double-taxation dilemma of corporations, and thus, gives them a tax advantage.
Shareholders in S Corporations also do not pay self-employment taxes (Social Security and Medicare) on their distributive share of profits.
For example, you are a 50% shareholder in an S Corp that had profits of $100,000. So your share of profits is $50,000. You will only pay federal income taxes on this amount so you end up saving quite a bit of cash.
If you also earned a salary of $80,000, the S Corp would withhold your federal income taxes, Social Security and Medicare and pay it on your behalf. So you end up paying Social Security and Medicare (self-employment taxes) on your wages only and not your distributive share of profits.
Estimated Tax Payments
Since S Corporation taxes flow through to you, the shareholder,, they must be paid to the IRS in the form of estimated tax payments. Each shareholder has this requirement. This is just the equivalent of tax withholding by your employer when you’re an employee.
All of your income and deductions for the year along with your tax withholding must be considered when determining your estimated tax payments. Since you are both a shareholder and an employee of the business, your taxes should be taken care of on the employee side so you should only have to worry about the shareholder side. Aren’t S Corporation taxes fun?
The estimated tax payments are paid in either one lump sum or in four equal, quarterly payments throughout the year. These payments can be made through the EFTPS (Electronic Federal Tax Payment System) website or through several other methods.
If you have a new business with a large amount of income late in the year, you will most likely need to adjust your estimated tax payments to accommodate the increase in your tax liability as the year progresses.
Just be sure to pay at least 90% of this year’s tax liability or 100% of last year’s tax liability (110% for high-income earners) to avoid penalties.
Paying Your Taxes
When you take money out of the business, you always need to think about your taxes. You will have to consider all of the income you have amassed throughout the year including any business profits. This will allow you to make sure your taxes are covered. Since estimated taxes are a personal expense, they cannot be paid directly from the business account. (The IRS frowns upon it.)
When you take a shareholder distribution, be sure to save for taxes. Your taxes will be withheld for your employee salary, but you still have to pay tax on the remaining business profits. If you had business profits of $100,000, then you owe taxes on your share of that $100,000. This is true even if you only took $10,000 in distributions. Taxes are based on profits not how much you take out.
Summing it up
So there you have it! S Corp taxes take a bit of work to sort through, but overall, it’s the same situation as any other business owner. You just have income from two different sources: employee and shareholder.
For your employee salary, the business will withhold your federal income taxes, Social Security and Medicare, but for your distributive share, you are responsible for paying federal income taxes.
You can download two flowcharts below showing how income and taxes work from the employee bucket and from the shareholder bucket.
To learn more about paying yourself in an S Corp, check out my blog post on S Corporation Salary Considerations.
Note: This blog post is meant for educational and informational purposes only. Please contact a tax or accounting professional if you have specific questions about what this means for your business before taking any further action.