S-corporations, like partnerships, are pass-through entities. That is, there is no federal income tax levied at the corporate level. Instead, an S-corporation’s profit is allocated to its shareholder(s) and taxed at the shareholder level.
Form 1120S is the form used for an S-corporation’s annual tax return. (This makes sense, given that Form 1120 is used for a regular corporation’s annual return.) As with a partnership, Schedules K and K-1 are used to show how the business’s different types of income and deductions are allocated among the owners.
Advantages of Filing Under Subchapter S
Establishing an S corporation may help establish credibility with potential customers, employees, suppliers, and investors by showing the owner’s formal commitment to the company. Also, the S corporation does not pay federal taxes at the entity’s level. Saving money on corporate taxes is beneficial, especially when a business is newly established. Other advantages include the transfer of interests in an S corporation without facing adverse tax consequences, ability to adjust property basis, and complying with complex accounting rules.
Disadvantages of Filing Under Subchapter S
Because S corporations can disguise salaries as corporate distributions to avoid paying payroll taxes, the IRS scrutinizes how S Corporations pay their employees. An S corporation must pay reasonable salaries to shareholder-employees for services rendered before distributions are made. Noncompliance such as mistakes in an election, consent, notification, stock ownership, or filing requirements, while rare, may result in the termination of an S corporation. Quick rectification of noncompliance errors can avoid any adverse consequences.
