If you want S-corp taxes explained without the sales pitch, here is the whole thing in two sentences. An S corporation generally pays no federal income tax itself — its profit flows through to your personal return — and the savings come from one place: money you take out as a distribution isn't hit by Social Security and Medicare taxes the way wages are. The catch is that you have to run payroll and pay yourself a reasonable salary before any of that works, and that's the half of the deal people who elected on a friend's advice usually never heard about.

Below: how the income actually reaches your return, where the savings come from, what "reasonable salary" means and how a court priced one, the returns and deadlines you now owe, and how to get out if the election was a mistake. This post is part of our small business tax planning guide.

How is an S corporation taxed?

As a pass-through: the S corporation generally pays no federal income tax on its profit, and each owner pays tax on their share. The IRS's S corporations page puts it in one line: "S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes." The corporation files its own return, Form 1120-S, but that return mostly reports rather than pays. Each owner gets a Schedule K-1 showing their share of the profit, and that share lands on the owner's Form 1040 at their own tax rates. If the K-1 itself is new to you, what is a K-1 walks through the form.

So for a single-owner business, the income tax picture barely moves when you elect. What changes is everything around it: you're now an employee of your own company, the company runs payroll, and the profit you take out comes in two different forms with two different tax treatments. The IRS also limits who can own one — no more than 100 shareholders, one class of stock, and no partnerships, corporations, or nonresident aliens as owners.

Where do the S-corp tax savings actually come from?

From one line on the pay stub: distributions carry no Social Security or Medicare tax, and wages do. Your salary is wages: it goes through payroll and carries Social Security and Medicare tax like any paycheck. What's left after salary and expenses can come out as a distribution, and the IRS's own guidance on S corporation compensation describes those as "non-wage distributions (which are not subject to employment taxes)." Compare that with a single-member LLC on Schedule C, where the whole net profit is subject to self-employment tax. That gap is the entire S-corp benefit.

It isn't free money, because the election brings costs: a payroll service, a separate corporate return, and in some states an extra entity-level tax or fee. Our threshold: when net profit clears $80,000 to $100,000 and looks repeatable, it's time to run the S-Corp math. Below that, the savings on the distribution slice usually don't beat the overhead. If you're still deciding rather than already elected, when to become an S-corp and LLC vs. S-Corp cover that decision; the rest of this post is for the owner who already filed Form 2553.

Do I have to pay myself a salary from my S corp?

Yes, if you work in the business. The IRS states it without wiggle room: "S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee." The Form 1120-S instructions say the same thing from the other side: "Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation."

Notice the word before. Payroll comes first; distributions come from what's left. This is the part that gets skipped when someone tells you "make it an S-corp, you'll save on self-employment tax" and stops talking. One owner on the TurboTax community boards found out at return time:

"2021 was the first year of my S-Corp. I am a solo shareholder, and I did not pay myself any salaries or wages. Company made 187k in income, and I did take 90k out of the business."

That pattern is the one I'd fix first on any S-corp return, and it isn't a paperwork glitch. With no salary, every dollar that came out looks like a distribution the IRS can re-label as wages — which is exactly what happened in the case below.

How much salary is "reasonable" for an S-corp owner?

Roughly what the business would have to pay someone else to do your job, judged by your training, your duties, and the hours you put in — for one CPA in a 2012 court case, that was $91,044 a year. The IRS's compensation guidance lists the factors it looks at, including "Training and experience," "Duties and responsibilities," "Time and effort devoted to the business," "Dividend history," and "Payments to non-shareholder employees." There's no published dollar floor, which is why the best guide is a case where a court actually set the number.

David Watson was a CPA with a master's degree in taxation and a background in partnership tax at Ernst & Young. In 1996 he formed his own professional corporation, elected S status from day one, and moved his 25% stake in a West Des Moines accounting firm into it. He was its sole officer, shareholder, director, and employee. For 2002 and 2003 his corporation paid him $24,000 a year in salary and passed the rest through as profit distributions — $203,651 in 2002 and $175,470 in 2003. The IRS assessed employment taxes on the difference. Watson paid one quarter, sued for a refund, and lost. The government's expert put the fair value of his accounting work at $91,044 a year; the district court adopted that number, found the salary understated by $67,044 a year, and entered a judgment of $23,431.23 in unpaid employment taxes, penalties, and interest.

The Eighth Circuit affirmed in David E. Watson, P.C. v. United States (2012), holding that "the characterization of funds disbursed by an S corporation to its employees or shareholders turns on an analysis of whether the payments at issue were made as remuneration for services performed." What you call the payment doesn't matter. What you did to earn it does. The court also shut the door on the no-salary version of the same move: "there is little difference if the employer pays no salary or pays a low salary that does not accurately reflect all remuneration for employment."

Two things are worth taking from Watson. First, a tax professional who knew the rules still got re-labeled, so this isn't a trap for the careless only. Second, look at where the court landed: about $91,000 of wages against roughly $200,000 of distributions. It didn't treat everything as salary. In our experience representing contractors in audits, a salary of roughly one-third of net profit is the level that consistently holds up. That's our planning starting point, adjusted for what you actually do and what the job pays in your market — how much salary an S-corp contractor should pay themselves goes deeper on setting the number.

What returns and deadlines does an S corp have?

Three layers. First, the corporate return: the instructions say "an S corporation must file Form 1120-S by the 15 day of the 3rd month after the end of its tax year," which puts a calendar-year 2026 return on March 15, 2027. Form 7004, filed by that date, extends it. Second, payroll: once you're on salary, the company files employment tax returns (Form 941 or 944, plus Form 940) and issues you a W-2. Third, your own Form 1040, where the K-1 lands.

Miss the 1120-S deadline and a penalty meter starts that doesn't care whether any tax was owed. Under Rev. Proc. 2025-32, for any return required to be filed in 2027, the amount used for the IRC § 6699 penalty is $260, charged for each month or part of a month the return is late (up to 12 months) and multiplied by the number of shareholders. A one-owner S corp that files three months late owes $780 before anyone looks at the tax. The IRS does list § 6699 among the penalties eligible for first-time abatement, so a clean history gets you a reset button, but the cheaper fix is a calendar reminder for March 15.

What if I took distributions but never ran payroll?

Fix it forward now, and get the past years looked at before the IRS does. The IRS's compensation page says it plainly: "The IRS has the authority to reclassify payments made to shareholders from non-wage distributions (which are not subject to employment taxes) to wages (which are subject to employment taxes)." That's what happened to Watson, and a no-salary year is the easier case for them, not the harder one.

The forward fix is simple: set up payroll, put yourself on a salary you can defend, and take distributions only from what's left. The backward question — what to do about years already filed with no wages — depends on the numbers and how many years are involved, and it's worth a preparer's hour before you amend anything or file the next 1120-S. The one thing not to do is keep going the same way because nobody has noticed yet. If you're working out how much to actually take home each month, how to pay yourself as a business owner covers the cash side, and contractor payroll taxes covers what the payroll itself costs.

Can I undo an S-corp election I made on someone's advice?

Yes: shareholders holding more than 50% of the shares can revoke it, but the company then generally has to wait five years to elect S status again. The Form 1120-S instructions set the terms: "An election can be revoked only with the consent of shareholders who, at the time the revocation is made, hold more than 50% of the number of issued and outstanding shares of stock." If the revocation doesn't name a date, it takes effect at the start of the current tax year when it's made "on or before the 15th day of the 3rd month of that tax year," and at the start of the next year otherwise. For a calendar-year company, that's mid-March.

The part to weigh before revoking: once the election ends, the company can elect S status again "only with IRS consent for any tax year before the fifth tax year after the first tax year in which the termination took effect." If profit is on its way up, revoking this year to avoid payroll could leave you locked out right when the election would start paying. Often the better answer to "my friend talked me into this" isn't revoking — it's running the S corp properly for a year and then looking at real numbers. The opposite problem, an election filed late, has its own relief under Rev. Proc. 2013-30.

What else do S-corp owners ask about taxes?

What should you do now that you're an S corp?

Get payroll running if it isn't, and set a salary you could explain to someone asking what you do all day — our starting point is roughly a third of net profit. Take distributions only after that. Put March 15, 2027 on the calendar for the Form 1120-S. And if the election was a mistake, remember the five-year wait before you revoke it.

Elected S-corp status and not sure the payroll side is right? N&T Tax & Advisory Group sets reasonable-salary levels for S-corp owners, reviews past years that ran without payroll, and prepares the Form 1120-S and K-1s — by phone or video, wherever the business is. Book a meeting with our team here.