S Corporation Advantage #2: Eliminate Corporate Income Taxes

S Corporation Advantage #2: Income Tax Savings

As compared to a regular C corporation, an S corporation saves corporate income taxes. How this savings occurs, though, is a little tricky. So let me explain.

How Corporate Income Taxes Usually Work

If a regular corporation makes $100,000, the corporation pays corporate income taxes on that profit. If the leftover, after-tax profit is paid to shareholders as dividend, the shareholders pay a second personal income tax on the dividend.

In the case discussed here, for example, the corporation might pay $20,000 of corporate income taxes on its $100,000 of profit (leaving $80,000 for dividends). And then the shareholder might pay another $12,000 of personal income taxes on its $80,000 of dividends.

How S Corporations Eliminate Corporate Income Taxes

In comparison, if an S corporation makes $100,000 in profit, the corporation pays no corporate income taxes on the profit. Rather, the profit is allocated to S corporation shareholders based on their ownership percentages. While the shareholders might pay around $25,000 in personal income taxes on their profit they won't pay any income tax on the dividend (or what's actually called a "distribution") when it's made.

In this simple example, the shareholders pay $25,000 of personal income taxes rather than $12,000 because of the S corporation. But the corporation doesn't have to pay the $20,000 of corporate income taxes.

An S corporation, therefore, means that the owners avoid a second, double tax. And avoiding the second, double tax means, of course, that as compared to a C corporation, an S corporation often saves business owners a substantial amount of income tax.

Note: You really have to work out with an accountant what the precise overall income tax savings are when comparing C corporations with S corporations. The savings amount depends greatly on the corporate and personal tax rates. Actual savings would probably be more if the corporate profits are very high and less if the corporate profits or shareholder incomes are very low.

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