Although perceived as a mix between a corporation and partnership, S corporations are required to file annual tax returns.
Key Takeaways
• An S corporation’s shareholders, not the corporation, pay federal income tax on the business profits.
• An S corporation’s income and deductions “pass-through” to each shareholder to be reported on their personal income tax returns in proportion to their respective shares of ownership.
• The S corporation has a responsibility to file an annual tax return on Form 1120S, providing the IRS with the details of the business’ earnings and expenses.
• The S corporation is responsible for preparing a separate K-1 for each shareholder to report their respective share of earnings and deductions on their own tax returns.
S corporation taxes
For tax purposes, an S corporation is somewhat of a hybrid entity that has characteristics of both a corporation and a partnership. Although it operates as a corporation, the business is not subject to double taxation since it is the shareholders, and not the corporation, who pay federal income tax on the business profits. Nonetheless, the S corporation must still file an annual corporate tax return.
Becoming an S corporation
In order to operate your business as an S corporation, you must satisfy a number of IRS requirements first. Your business must operate as a domestic corporation, have only one class of stock and have no more than 100 U.S. shareholders.
If you satisfy these three requirements, then you must file Form 2553 to elect S corporation treatment by the IRS. When you do, the business is then subject to a different form of taxation than typical corporations.
S corporation taxation
Most corporations are subject to the C corporation tax rules, which include double taxation. This means that the business is responsible for paying income tax on its earnings, and then the shareholders are responsible for paying a second tax when they receive dividends from the corporation.
However, an S corporation doesn’t pay any tax to the IRS. It is treated similarly to a partnership in that the income and deductions “pass-through” to each shareholder to be reported on their personal income tax returns in proportion to their respective shares of ownership.
TurboTax Tip: As an S corporation shareholder, you need to incorporate the amounts reported on your K-1 into your own income tax return.
Annual business tax returns
Even though the S corporation does not pay income tax, it has a responsibility to file an annual tax return on Form 1120S. This tax form is for informational purposes only and provides the IRS with an aggregate view of the business’ earnings and expenses.
Along with the Form 1120S, the S corporation is also responsible for preparing a separate K-1 for each shareholder to report their respective share of earnings and deductions on their own tax returns.
To illustrate, suppose your S corporation has 10 equal shareholders and earns $1 million in revenue and reports $500,000 in deductible expenses. In most cases, the S corporation must attach 10 K-1s to the Form 1120S, each of which should report $100,000 in revenue and $50,000 in expenses to each shareholder. All of these forms are due to the IRS by the 15th day of the third month following the close of the tax year, which is usually March 15.
Shareholder tax returns
Each shareholder of an S corporation will receive a copy of their K-1 that the corporation prepares. As a shareholder, you must incorporate the amounts reported on your K-1 into your own income tax return. Therefore, when your receive the K-1 with $100,000 in income and $50,000 in deductions, your personal income tax return will include an additional $50,000 of taxable income from the business that you are responsible for paying tax on. Since you include these amounts on your own tax return, you must follow the appropriate deadlines for your Form 1040, which is for 2023 tax returns.
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