Advantages of the S corp!

Besides its single level of taxation, an advantage of an S corporation over a C corporation is that a shareholder’s share of the corporation’s net income is not considered self-employment earnings and therefore is not subject to self-employment tax (13.3% in 2011 and 2012). This treatment is in contrast to that of a general partner, LLC member, or sole proprietor, for whom net earnings from self-employment include any trade or business income and a partner’s distributive share of income from a trade or business carried on by the partnership (Sec. 1402(a)).
However, if the S corporation shareholder provides services to the S corporation, he or she must receive an adequate or reasonable amount of compensation for these services. The S corporation may deduct the compensation expense and must pay the employer share of employment taxes: 6.2% Social Security tax and 1.45% Medicare tax. The shareholder-employee is responsible for 4.2% Social Security tax (in 2011 and 2012) and 1.45% Medicare tax. The S corporation is also responsible for Federal Unemployment Tax Act (FUTA) taxes. Minimizing these taxes provides an incentive to keep the S corporation shareholder’s wages low and to characterize most of the passthrough income as distributions.