Here’s Something to Think About

To answer this question, we should first ask, “What is an S corporation?”

An S corporation is a company, that is organized as a corporation or limited liability company (LLC), and elects S corporation status with the IRS by filing form 2553.

What makes an S corporation special?  There are three other ways for you to organize your company for income tax purposes: sole proprietorship, partnership, or C corporation.  Let’s compare S corporations with each of these types of tax structures.  Let’s start with the sole proprietorship.

First, a sole proprietorship has only one owner.  An S corporation may have up to 100 owners, called shareholders. 

Second, both the sole proprietorship and the S corporation pass taxable income through to the owner or owners.  However, the sole proprietorship reports income and expenses directly on the owner’s personal tax return.  The S corporation files a separate tax return and provides each shareholder with a K-1 form for the owners to use in reporting the income on their personal tax returns.

Third, the shareholders of an S corporation are also employees if they work for the company.  In other words, they are required to take a fair salary for their efforts and receive a W-2 form from the company at year end.  Sole proprietors are not allowed to take a W-2 eligible salary.  They distribute profits directly to themselves.

Finally, owners of sole proprietorships pay self-employment tax (Social Security and Medicare) on all taxable profit.  Shareholders of S corporations only pay Social Security and Medicare on their salaries.  Any profit above salaries escapes Social Security and Medicare taxes.

Let’s compare S corporations with partnerships. 

First, a partnership must have more than one owner.  An S corporation may have one or more owners.

Second, both partnerships and S corporations file separate tax returns and pass through taxable income to the owners by way of the K-1 form mentioned above.

However, partners in a partnership do not take a salary from the company.  If they work for the company, they receive guaranteed partner payments for their services.  A guaranteed partner payment does not result in the issuance of a W-2 and has no taxes withheld.  As mentioned earlier, S corporation shareholders receive W-2 salaries.

Third, both profit and guaranteed partner payments for partners are subject to self-employment tax, just the way sole proprietors are subject to self-employment tax on all profits.  S corporation owners only pay Social Security taxes on their salaries.

Let’s compare S corporations with C corporations.

Both file tax returns separately from owners.  However, as mentioned above, S corporation owners receive a form K-1 for profits and pay taxes on those profits on their personal tax returns.  A C corporation pays its own taxes on its corporate tax return.

In addition, the owners of a C corporation pay personal taxes on any dividends that they receive from the company.  There are two levels of taxation on a C corporation.

We have not addressed the best entity type for your business.  That is dependent on a lot of factors, and at S&K we provide business owners with advice in this complex area. 

We have also not discussed which tax structures tend to lead to the lowest total taxes.  I will tackle this in my next blog post.

If you have any questions, please contact me at or call (703) 818-8284.

Thanks for reading!

Frank Stitely, CPA, CVA