Tax on Profit

• Tax assessment of S corp's income is determined on the personal tax returns of shareholders. S corporation shareholders are taxed on their share of profit regardless of whether it's distributed to them. Because shareholders have already paid tax on S corp profit, there is no double taxation on distributions of profit, as is the case with dividends from regular C corporations.
  
  

Tax on Distributions

• Distributions are taxable capital gain income if they exceed the S corp basis of the receiving shareholder. Every shareholder has a stock basis and a loan basis. Stock basis consists of amounts invested in the S corp plus the shareholder's accumulation of undistributed profits. Loan basis consists of any amount the S corp has borrowed from the shareholder minus repayments.
  
  

Reasonable Wages

• The Internal Revenue Service has rules about taxable wages of a reasonable amount for an S corp shareholder who contributes personal services to the business. Some of the factors used to determine if these wages are reasonable include the shareholder's duties and wages paid for similar services at comparable businesses. If most of an S corp's income is derived from services provided by shareholders, the IRS requires allocating most payment to shareholders as wages rather than tax-free distributions.
  
  

Employment Taxes

• When S corp profit is taxed at the shareholder level, only regular income tax is paid. Shareholders are not assessed self-employment tax, which covers contributions to Social Security and Medicare. Unlike unincorporated proprietors, business profit for an S corp is not considered self-employment income. However, S corp shareholders who provide more than minor services to the business must receive payment as wages, instead of all as tax-free distributions. These wages do incur employment taxes for Social Security and Medicare.