An S-Corporation is a tax status created by the tax code that determines how a business will be treated for taxation purposes. It is just a tax election that can be made by Corporations, LLCs and even Partnerships.
In a nut shell, a business’s taxable income & loss “passes” from the entity to the owners so it is taxed only at the ownership level. Note that the passing of income is for tax purposes only and has nothing to do with actual cash or asset distributions.
Another potential tax advantage comes to partnerships and LLCs that make the election is potential reduction of self-employment tax. In this case the owners can hold two positions relative to the business; that of employee and, that of investor. As an employee, the shareholder must draw a reasonable salary and payroll taxes must be paid and tax returns filed. The rest of the income passes through as investment income thereby reducing total employment tax. Fortunately reasonable does not preclude an aggressively low manager’s salary, enhancing the potential benefit.
This beneficial position is not without cost and responsibility. To claim owner’s salaries, they must be paid and taxes withheld and employment tax returns filed as with all employees. While aggressively low can be acceptable, $0 salary is not. Additionally losses in excess of basis present a problem as do owner’s distributions in times of loss. For the S election to be effective the proper forms must be filed (2553 or 8869) timely and there are ownership restrictions.
In short, an s-corp. can have some marvelous tax benefits but each situation needs to be looked at with your CPA and the pro’s and con’s weighed.