Financial Glossary
S Corporation (S Corp)
An S Corporation is a domestic corporation that has elected to be taxed under Subchapter S of the Internal Revenue Code, causing its income, losses, deductions, and credits to pass through to individual shareholders, who report them on personal tax returns. This avoids the double taxation inherent in C corporation structure (corporate-level tax on earnings plus personal-level tax on dividends). To qualify, an S corp must have no more than 100 shareholders, all of whom must be US citizens or residents; only one class of stock is permitted; certain entity types (other corporations, partnerships, many trusts) cannot be shareholders. Shareholder-employees of an S corp must receive reasonable compensation reported on W-2, which is subject to payroll taxes -- only distributions above that compensation avoid FICA taxes.
Problem & Application
A fractional CFO advisor running a consulting practice nets $300,000 annually. Structured as a sole proprietorship, the entire $300,000 is subject to self-employment tax (approximately 15.3% on the first portion, 2.9% above the Social Security wage base). Electing S corp status and paying herself a reasonable salary of $120,000 shifts the remaining $180,000 to pass-through distribution, which is not subject to self-employment tax. The estimated SE tax savings on the $180,000 distribution is roughly $13,000 to $15,000 annually, partially offset by the cost of payroll processing and the additional administrative burden of corporate formalities, a separate tax return (Form 1120-S), and annual filings. Net savings are meaningful for profitable owner-operated service businesses generating over roughly $80,000 to $100,000 in net income, but the math must be run for each client's specific situation. Parikh Financial would model the breakeven point, handle the S corp election filing, set up payroll, and ensure the reasonable compensation level is documented to withstand IRS scrutiny.
In Short
For qualifying businesses, S Corp status offers significant tax advantages, but careful compliance with IRS regulations is required.