S corporations are preferred by small business owners because they provide pass-through taxation and limited liability protection. S corporations are exempt from federal income tax. Instead, the shareholders receive the business’s income, credits, and deductions, which they then record on their personal tax forms. Payments provided to shareholders from the company’s profits are known as S corp distributions. When compared to normal wages or salaries, these distributions are taxed differently.
Payroll taxes, such as Social Security and Medicare taxes, are often exempt from S corp dividends. Comparing individuals who receive their income as wages or salaries to those who receive it as S corp shareholders, this can result in huge tax savings. Distributions from S corporations are nevertheless remain taxable. Whether a payout is regarded as a dividend or a capital return affects how much tax is due on it.
Distributions of dividends are subject to ordinary income tax at the shareholder’s marginal tax rate. These dividends are funded by cumulative earnings and profits of the business. Return of capital distributions, however, are not subject to taxation. These payouts are financed by the shareholder’s investment in the business. The basis in the company that is reduced by return of capital distributions might have an effect on a shareholder’s future tax obligations.
LLC S corps are not a distinct category of business entity. By submitting Form 2553 to the IRS, LLCs can elect to be taxed as S corporations. A Form 1099-MISC must be issued to a non-employee and filed with the IRS if an LLC S corp pays a non-employee more than $600 in a given tax year. By January 31st of the following year, the LLC S corp must also send a copy of the Form 1099 to the non-employee. The LLC S corp does not have to send a Form 1099 if it exclusively pays employees.