The big benefit of S-corp taxation is that S-corporation shareholders do not have to pay self-employment tax on their share of the business’s profits. Her revenues from the business are $60,000 per year, and her annual expenses total $10,000. Therefore, her S-corp’s profit for the year is $50,000. This exact question is frequently the topic of debate in court cases between the IRS and business owners who are, allegedly, paying themselves an unreasonably small salary to save on self-employment taxes. A shareholder’s cost basis in an S-corporation is increased by his allocated share of the business’s income and by contributions he makes to the business. His basis will be decreased by his share of the business’s losses and by distributions he receives from the business. In the calendar year in which the business is formed, the business pays Austin a salary of $30,000, after which it has remaining ordinary business income of $20,000. The $30,000 salary will be taxable to Austin as ordinary income, and it will be subject to normal payroll taxes as well. The $20,000 ordinary business income will be taxable to Austin as ordinary income, but it will not be subject to payroll taxes or self-employment tax. Of note, any compensation that the S-corporation pays to you is not considered to be pass-through income. It is only allocations of profit from the S-corporation that are pass-through income.
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