S Corporation Tax Basics: Essential Facts for Business Owners

What is an S Corporation?

An S Corporation isn’t a separate type of business. It’s a special tax status that a business can choose, so it’s taxed differently by the IRS.

S Corporations vs. LLCs

It’s important to understand that for tax purposes, a Limited Liability Company (LLC) isn’t automatically separate from its owner. By default, it’s taxed the same way as a sole proprietorship (for one owner) or a partnership (for multiple owners).

The main difference is that S Corporations can help owners save on self-employment taxes. After paying themselves a reasonable salary, any remaining profit (called residual income) isn’t subject to the 15.3% self-employment tax.

What is self-employment tax?

Self-employment tax includes both Social Security and Medicare taxes. When you’re self-employed, you’re responsible for paying both the employer and employee portions, which together total 15.3% of your net income—on top of any other taxes you owe.

This example highlights the advantage of choosing S Corporation taxation. With these assumptions, the income level shown results in about $3,060 in tax savings—and as your income grows, your potential savings can increase even more.