If you own a profitable S corporation, are you wondering how much income tax you’ll pay on those profits? This article will answer that question.
S corporation profits are reported on Schedule K-1. This K-1 is prepared as part of the corporation’s federal income tax return, which consists of Form 1120S, the K-1, and any other tax forms needed to complete the return.
A Schedule K-1 is prepared for each shareholder of the corporation. If you own 100% of the corporation’s stock, then there will be only one K-1, issued to you, and it will show you as the one responsible for reporting 100% of the corporation’s profit. If you have two shareholders, each owning 50% of the corporation’s stock, then there will be two K-1’s, one for each shareholder, showing that each shareholder is responsible for 50% of the corporation’s profit.
What do I mean by the phrase “responsible for reporting 100% (or 50%) of the corporation’s profit”? Generally speaking, S corporations do not pay federal income tax on the corporation’s profit. Instead, the shareholder(s) are liable for the federal income tax on corporate profits by reporting those profits on their personal income tax return. So if you own stock in an S corporation, you should receive a K-1 every year and you must report the income from that K-1 on your personal income tax return. And it is critical that you do so, because the IRS also receives a copy of that K-1 and will be expecting to see that K-1 profit on your personal tax return.
So, how much federal income tax will you pay on your S corporation profits? The answer to that question is simply this: whatever your marginal federal income tax rate happens to be. If you are in the 15% tax bracket, you’ll pay 15% on the K-1 profits. If you are in the 25% bracket, you’ll pay 25%. And so on.
Here’s another critical fact of S corporation tax law: you will pay federal income tax on your K-1 profit whether or not you have actually received that profit as a cash distribution. The corporation is not required to distribute the profits to the shareholders. That is really up to the corporation. But the point is, even if the corporation doesn’t pay you the profit, you must still report that profit on your personal income tax return, and you are therefore required to pay the tax on the profit whether or not you have received it. This is one of the most overlooked aspects of S corporation taxation, so please do not ignore this important fact.