An S corporation generally pays no federal income tax on its profits. Those profits pass through to shareholders, who report them on their personal returns and pay tax at their individual rates. But the “no tax” shorthand hides real obligations: an S corp still owes payroll taxes on every dollar of wages, can owe corporate-level federal tax in specific situations, and faces state taxes that do not always follow the federal pass-through treatment. So the honest answer to what taxes S corps pay is: payroll taxes always, a handful of federal corporate taxes sometimes, and whatever the state decides on top.
Federal Income Tax Passes Through to Shareholders
The S corp files Form 1120-S each year to report income, deductions, and credits, but the business itself does not pay income tax on those amounts.1Internal Revenue Service. About Form 1120-S, U.S. Income Tax Return for an S Corporation Each item flows through to shareholders based on ownership percentage.2Office of the Law Revision Counsel. 26 USC Subtitle A, CHAPTER 1, Subchapter S – Tax Treatment of S Corporations and Their Shareholders Every shareholder receives a Schedule K-1 and reports their share on personal Form 1040.3Internal Revenue Service. Instructions for Form 1120-S
Pass-through means you owe tax on your share of profits whether or not you take a cash distribution. If the company earns $200,000 and you own 50%, you report $100,000 even if every dollar stays in the business account. Your rate is your personal bracket, not a flat corporate rate.
Payroll Taxes on Wages Always Apply
Every dollar of salary the S corp pays to shareholder-employees and any other employees triggers payroll tax. This is the tax an S corp cannot escape.
Social Security and Medicare (FICA)
The employer pays 6.2% for Social Security and 1.45% for Medicare on each employee’s wages, and the employee pays the same amounts through withholding.4Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates The Social Security portion applies only up to the annual wage base, which is $184,500 for 2026.5Social Security Administration. 2026 Cost-of-Living Adjustment (COLA) Fact Sheet Medicare has no wage cap. The corporation reports and deposits these quarterly on Form 941.6Internal Revenue Service. About Form 941, Employer’s Quarterly Federal Tax Return
Additional Medicare Tax
Employees who earn above certain thresholds owe an extra 0.9% Medicare tax on the excess. The threshold is $200,000 for single filers and $250,000 for married couples filing jointly. The employer does not match this tax, but must begin withholding the additional 0.9% once an employee’s wages pass $200,000 in a calendar year, regardless of filing status.7Internal Revenue Service. Questions and Answers for the Additional Medicare Tax
Federal Unemployment Tax (FUTA)
The corporation pays federal unemployment tax at 6.0% on the first $7,000 of each employee’s annual wages. Only the employer pays. Most employers receive a 5.4% credit for state unemployment taxes already paid, bringing the effective rate to 0.6%.8Internal Revenue Service. FUTA Credit Reduction The corporation files Form 940 annually.9Internal Revenue Service. About Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return
Deposit Schedules
Payroll tax deposits follow a monthly or semi-weekly schedule based on the corporation’s tax liability during a lookback period. Monthly depositors pay by the 15th of the following month. Semi-weekly depositors have tighter deadlines tied to each payroll date. If total liability reaches $100,000 or more on any single day, you must deposit by the next business day.10Internal Revenue Service. Employment Tax Due Dates
The Reasonable Compensation Trap
Shareholder-employees typically receive both a salary and profit distributions. Salary is subject to payroll taxes; distributions are not. That gap creates a strong incentive to underpay salary. The IRS watches closely.
Any shareholder who provides services must receive a reasonable salary before taking distributions. Reasonable means what a comparable business would pay someone with similar qualifications for similar work.11Internal Revenue Service. Wage Compensation for S Corporation Officers If the salary looks artificially low, the IRS can reclassify distributions as wages, triggering back payroll taxes plus penalties and interest.12Internal Revenue Service. S Corporation Employees, Shareholders and Corporate Officers Factors the IRS weighs include your training and experience, hours devoted to the business, comparable pay in similar businesses, whether the company’s income depends mainly on your personal services, your distribution history, and the size and complexity of the operation. Keep compensation surveys, job descriptions, and time records if you want a defense ready.
Federal Corporate-Level Taxes That Sometimes Apply
Although S corps generally avoid federal income tax, three situations force the corporation itself to pay. All three apply only to S corps that previously operated as C corps. The rate on the first two is the flat 21% corporate rate.13Office of the Law Revision Counsel. 26 USC 11 – Tax Imposed
Built-In Gains Tax
When a C corp converts to an S corp, appreciation that built up during the C corp years does not escape tax. If the S corp sells those assets within five years of conversion, it owes built-in gains tax at 21% on the gain that existed at the time of conversion.14Office of the Law Revision Counsel. 26 USC 1374 – Tax Imposed on Certain Built-in Gains Accurate appraisals on the conversion date matter here, because those values set the baseline dividing built-in gain from post-election appreciation.
Excess Net Passive Income Tax
An S corp that carries accumulated earnings from its C corp days and collects more than 25% of its gross receipts from passive sources (rents, royalties, dividends, interest, annuities) owes tax on its excess net passive income. The rate is the highest corporate rate, currently 21%, applied to passive income exceeding the 25% threshold.15Office of the Law Revision Counsel. 26 USC 1375 – Tax Imposed When Passive Investment Income of Corporation Having Accumulated Earnings and Profits Exceeds 25 Percent of Gross Receipts
The bigger risk comes with time. If the corporation exceeds the 25% threshold for three consecutive years while holding accumulated C corp earnings and profits, the S election automatically terminates, effective the first day of the tax year following the third year.16GovInfo. 26 USC 1362 – Election; Revocation; Termination Distributing the accumulated C corp earnings before the three-year mark eliminates both the tax and the termination risk.
LIFO Recapture Tax
A C corp that valued inventory under the last-in, first-out (LIFO) method must recapture the difference between LIFO and FIFO values on conversion. The recapture amount is included in gross income for the final C corp tax year. The resulting tax is payable in four equal annual installments: the first with the final C corp return, the remaining three with each of the next three S corp returns.
Shareholder-Side Federal Tax on Pass-Through Income
Because S corp income is not subject to corporate-level withholding, shareholders pay tax on their pass-through share through quarterly estimated payments using Form 1040-ES.17Internal Revenue Service. Estimated Taxes For 2026, the four deadlines are April 15, June 15, and September 15 of 2026, and January 15, 2027.18Internal Revenue Service. Form 1040-ES, Estimated Tax for Individuals You can skip the January payment if you file your full return and pay the remaining balance by February 1.
If you owe $1,000 or more when you file, you generally need to make these estimated payments. Falling short triggers an underpayment penalty, though paying at least 100% of the prior year’s tax liability (110% if your income exceeded $150,000) is a safe harbor that avoids the penalty even if you owe a balance.19Office of the Law Revision Counsel. 26 USC 6654 – Failure by Individual to Pay Estimated Income Tax
When the S corp itself owes tax (built-in gains, excess net passive income), the corporation must make estimated payments if the expected tax is $500 or more, deposited through the Electronic Federal Tax Payment System (EFTPS). The IRS discontinued the standalone Form 1120-W worksheet in 2023; corporations now calculate their estimated liability using Publication 542 and deposit through EFTPS.
The QBI Deduction and 2026
Through 2025, S corp shareholders could deduct up to 20% of qualified business income under Section 199A. Under current law, the deduction applies only to tax years ending on or before December 31, 2025, meaning it is not available for 2026 returns.20Internal Revenue Service. Qualified Business Income Deduction Congress could extend or make permanent the deduction; check for legislative updates before filing.
State and Local Taxes
States are not required to follow the federal S corp election, and their treatment varies. Some states tax S corps as pass-through entities the way the federal government does. Others ignore the S election entirely and tax the corporation’s income at their regular corporate rate. A few impose a reduced corporate-level tax or a flat tax on S corp income in addition to the shareholder-level tax.
Franchise and Privilege Taxes
Many states charge a franchise or privilege tax for the right to operate as a corporation there. These taxes are often based on net worth, total assets, or authorized shares rather than annual profit. Some states charge a flat annual fee regardless of size. Annual fees to maintain active corporate status range from under $100 to several hundred dollars in most states, though some jurisdictions charge significantly more based on company size or revenue. Failing to pay can cost you corporate good standing, which may prevent you from filing lawsuits or entering contracts in that state.
Nonresident Shareholder Withholding
If shareholders live in a different state from where the S corp operates, the business state often requires the corporation to withhold income tax on their behalf or file a composite return covering all nonresident shareholders. This ensures the business state collects tax on income earned within its borders. Shareholders subject to withholding or included in a composite return should receive credit on their home-state returns for taxes paid to the business state, though the mechanics differ by jurisdiction.
Penalties That Turn a Missed Filing Into Real Money
Late Filing Penalty
If the S corp files Form 1120-S late or leaves out required information, the penalty is $255 per shareholder for each month or partial month the return is late, up to 12 months.3Internal Revenue Service. Instructions for Form 1120-S Four shareholders means $1,020 per month and a potential maximum of $12,240. The penalty applies even when the company owes no tax, because Form 1120-S is an informational return the IRS uses to verify shareholder reporting.
Trust Fund Recovery Penalty
Amounts withheld from employee paychecks for income tax, Social Security, and Medicare are held in trust for the government. Officers or others responsible for depositing those taxes who willfully fail to do so can be held personally liable for the full amount. Willfulness does not require bad intent; choosing to pay other creditors instead of depositing payroll taxes is enough.21Internal Revenue Service. Employment Taxes and the Trust Fund Recovery Penalty (TFRP) This penalty attaches to the individual and pierces the corporate shield.
Reclassification of Distributions as Wages
The IRS can reclassify distributions as wages when a shareholder-employee’s salary is unreasonably low. Reclassification triggers the employer and employee portions of FICA on the reclassified amount, plus penalties for failure to withhold and interest on the unpaid balance.12Internal Revenue Service. S Corporation Employees, Shareholders and Corporate Officers Courts have consistently upheld the IRS’s authority to recharacterize these payments, even when the shareholder argued the amounts were legitimate profit distributions.