When you’re running a business, every dollar counts and every decision matters. From choosing how to pay yourself to keeping Uncle Sam happy, the way your business is set up can have a big impact on your wallet.
S corporations (S-corps) remain a top business status choice for small business owners. This guide details how S-corps work, how they are taxed, what’s new for 2026, and how accounting software and payroll services for S-corps simplify compliance for busy business owners.
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The IRS defines an S corporation as a “small business corporation that has made a valid election to be taxed under Subchapter S of the Internal Revenue Code” by filing Form 2553. S-corp status offers several advantages, including simpler taxation, potential savings on self-employment taxes, and flexibility in how owners pay themselves.
S corporations are pass-through entities. That means the business itself doesn’t pay federal income tax. Instead, profits and losses “pass through” to the shareholders, who report them on their personal tax returns. This avoids the “double taxation” that C corporations face, where income can be taxed at both the corporate and shareholder levels.
On those personal tax returns, shareholder-employees must split cash payments between a reasonable salary (subject to payroll taxes) and distributions (not subject to payroll taxes). The IRS pays close attention to this distinction, so S-corp owners in 2025 need to carefully document how they compensate themselves.
Example: An S-corp has $120,000 in cash available to pay out to its single shareholder. The shareholder takes a reasonable salary of $70,000 and the remaining $50,000 as a cash distribution. Only the salary of $70,000 will be subject to payroll taxes. This can save the owner thousands of dollars compared to being taxed as a sole proprietor.
And that’s not the only thing S-corp owners should pay attention to. The One Big Beautiful Bill Act (OBBBA) made several tax provisions permanent, including higher standard deductions and broader employee fringe benefit deductions.
Most importantly for small business owners, the Qualified Business Income (QBI) deduction remains at 20% for pass-through entities such as S-corps. That means eligible owners can deduct up to 20% of their qualified business income, directly lowering the taxable income reported on their personal returns.
Both S corporations and C corporations offer liability protection, but they differ in how they’re taxed, who can own them, and how they raise money. Here’s a quick side-by-side look at the main differences.
Many small business owners select S-corp status because it combines the liability protection of a corporation with tax benefits that can reduce overall costs. Let’s break down some of the most common reasons:
Avoid double taxation
Unlike C corporations, S-corps do not pay federal income tax at the corporate level. Profits and losses pass directly through to shareholders and are reported on their personal tax returns, so income is only taxed once.
Potential for self-employment tax savings
Shareholder-employees of an S corporation can pay themselves a “reasonable salary” subject to payroll taxes. Their remaining share of S corporation income after the salary deduction is not subject to self-employment tax. In contrast, sole proprietors pay self-employment tax on all net income earned from their business. This structure often results in a lower tax liability compared with operating as a sole proprietor or partnership.
Access to the Qualified Business Income (QBI) deduction
The 20% pass-through deduction remains in place for 2025 and has been made permanent under the OBBBA. While not exclusive to S corps, qualifying owners can still reduce taxable income by up to 20%, making it a valuable benefit.
Simpler ownership structure than a C corporation
With a shareholder limit of 100 and a requirement that all owners be U.S. citizens or residents, the structure naturally keeps ownership small and manageable. For many entrepreneurs, these rules are a benefit—they simplify decision-making, reduce complexity, and allow owners to stay closely connected to the business without pressure from large outside investors.
Ability to offset income with losses
Business losses can flow through to shareholders and may offset other personal income (subject to IRS rules), which can provide relief in years when the business isn’t profitable.*.*
Running an S-corp means staying on top of several federal and state tax forms. Each serves a specific purpose, and missing one can create problems with the IRS or state agencies. Here are the forms you need to understand to stay compliant:
Form 1120-S is the annual tax return for S corporations. It reports the company’s income, deductions, gains, losses, and distributions. Even though S-corps generally don’t pay federal income tax at the corporate level, the IRS still requires this return to track how profits and losses flow to shareholders.
An integral part of preparing and filing Form 1120-S is preparing a Schedule K-1 for each shareholder. This form shows the shareholder’s portion of the company’s income, deductions, credits, and other tax items. Shareholders don’t fill out the K-1 themselves—they use the copy provided by the S corporation to complete their own personal tax returns.
The IRS requires expanded reporting for S-corps with international activities. If an S-corp has foreign income, foreign taxes paid, or international credits, it may need to include Schedules K-2 and K-3 (Form 1120-S).
If your S-corp has employees—including shareholder-employees taking a salary—you must file payroll forms:
In addition to federal requirements, most states require annual or franchise tax filings for S-corps, and many have their own versions of K-1s or income reports.
Choosing to run your business as an S corporation can open the door to powerful tax advantages. From saving on employment taxes to taking advantage of deductions for retirement plans and healthcare, these benefits can make a significant difference in your business’s bottom line. Below are the primary tax advantages that come with S-corp status and how they work in practice.
One of the biggest draws of an S-corp is the ability to split income between a salary and profit distributions. The salary portion is subject to payroll taxes, but profit distributions are not. This structure can reduce overall employment taxes while still complying with IRS rules.
S-corp owners may also qualify for the 20% Qualified Business Income (QBI) deduction on non-wage profits. This deduction, now permanent under 2025 tax law, can lower taxable income for eligible shareholders. Salary paid to owners doesn’t count toward QBI, but the share of S-corp income allocated to a shareholder does.
Like other business structures, S-corps can deduct ordinary and necessary business expenses. These include rent, utilities, equipment purchases, advertising, and insurance. Deducting these expenses reduces net income, which in turn reduces the amount that flows through to the shareholder’s return.
S corporations can sponsor retirement plans such as a solo 401(k) or SEP IRA, as well as provide health benefits. Contributions to these plans are often deductible for the corporation and can provide tax-advantaged savings for owners and employees. Health insurance premiums for shareholder-employees may also be deductible under specific IRS rules.
S corp owners can adjust the balance between salary and profit distributions to help manage overall tax liability while keeping IRS rules for “reasonable compensation” in mind.
In 2025, the standard deduction has increased to $15,750 for single filers, $31,500 for married couples filing jointly, and $23,625 for heads of household. Income thresholds for each tax bracket were also adjusted for inflation. Combined with the permanent 20% QBI deduction, these updates mean the most tax-efficient salary-to-distribution mix may look different than in prior years.
While S corporations provide tax benefits, they require following specific rules to stay compliant. Without careful planning, small business owners may run into penalties, higher taxes, or added IRS scrutiny. Here are some of the most common pitfalls and ways to avoid them.
A common mistake is taking all payments to owners as distributions instead of dividing compensation between a reasonable salary and distributions. The IRS requires shareholder-employees who work in the business to be paid wages, which are subject to payroll taxes.
Even when owners pay themselves a salary, mistakes in payroll withholding or reporting can create compliance issues. This includes failing to deposit payroll taxes on time or filing the wrong forms.
Mixing business and personal expenses is a frequent red flag. It complicates tax filings and can undermine the liability protection of your corporate structure.
Form 1120-S and shareholder Schedule K-1s are due on March 15 (or the 15th day of the third month after the tax year ends). Late filings can trigger penalties for both the corporation and its shareholders.
Each year, there’s a limit on how much of your salary is subject to Social Security tax. In 2025, that limit (called the wage base) went up to $176,100. If your S-corp salary is at or above that level, you’ll owe Social Security tax on a bigger portion of your pay than you did in 2024.
Shareholder “basis” is basically your investment in the S-corp, which changes over time as the business earns profits, takes losses, or makes cash distributions. Your basis sets the limits on two things:
If you don’t keep track, you could claim losses you’re not allowed or fail to report taxable income.
While the IRS governs S corporation status at the federal level, not all states recognize S-corps in the same way. Some impose franchise taxes or require a separate election.
S-corp election benefits business owners in these scenarios:
Here’s a quick look at the main advantages and drawbacks of electing S-corp status for your business:
2025 update
With OBBBA’s inflation adjustments to brackets and deductions, the break-even point for S-corp election has shifted. Owners who were on the fence in prior years may now see more substantial benefits.
Any S-corp business owner can tell you, S-corp payroll taxes can be complicated. But QuickBooks Online Payroll—the #1 payroll provider for small businesses¹—makes it simple. It automates payroll, files federal and state taxes, and ensures you meet “reasonable compensation” rules with W-2s at year’s end. You’ll get clean, tax-ready reports, seamless accountant access, and peace of mind with tax penalty protection, which covers and reimburses penalties if errors occur. With QuickBooks, tax season doesn’t run you—you run it.
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