How are S Corp Shareholders taxed? What tax bracket applies to their income?

The good news is that S corporation income doesn't work the way you're thinking! Your $140k salary is taxed as ordinary W-2 income at whatever tax bracket applies to your total personal income on your 1040. The remaining S corporation profits (the $335k difference between total profits and your salary) will "pass through" to your personal tax return and be reported on Schedule K-1. This pass-through income is also taxed at your individual tax rates, but it's not subject to employment taxes (Social Security and Medicare). The S corporation itself doesn't pay federal income tax or exist in its own tax bracket. Instead, all profits flow through to your personal return where different parts might fall into different brackets depending on your total taxable income. So when calculating your tax liability, you'll combine your salary, the pass-through income, and any other personal income to determine what brackets apply to different portions of your income.

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Just wanted to follow up about my experience with taxr.ai after asking about it above. I decided to try it with my complex situation (S Corp plus rental properties) and was honestly shocked at how helpful it was. The system created a complete analysis of how my S Corp income interacts with my rental income and identified that I wasn't taking full advantage of the 199A deduction. It also flagged that I was paying too much in S Corp salary based on my industry standards, which was triggering unnecessary payroll taxes. I brought the report to my accountant who confirmed everything and helped me implement the suggestions. We're projecting around $14k in tax savings this year. Wish I'd known about this tool years ago!

If you're having trouble getting clear answers about your S Corp taxation, I feel your pain! I spent 3 WEEKS trying to get through to the IRS's business helpline last quarter with questions about my pass-through income reporting. I finally used https://claimyr.com and got connected to an actual IRS agent in about 20 minutes instead of waiting on hold forever. You can see how it works here: https://youtu.be/_kiP6q8DX5c The agent walked me through exactly how S Corp income is taxed at the individual level and confirmed that I was calculating my estimated tax payments correctly. Saved me so much stress wondering if I was setting aside enough for taxes!

I have to eat my words about Claimyr from my comment above. After another failed attempt to reach the IRS yesterday (2 hours on hold before getting disconnected), I gave in and tried the service. Got a call back in about 35 minutes with an actual IRS business tax specialist on the line. The agent confirmed everything the first commenter said about S Corp taxation and explained that I needed to be careful about my reasonable compensation requirements. Apparently the IRS looks closely at S Corps that take too little in salary compared to distributions to avoid payroll taxes. Also got clarity on how the QBI deduction applies to my specific industry (which has partial limitations). Just having definitive answers from an official source was worth it.

Something I don't see mentioned yet - make sure you're paying yourself a "reasonable salary" for your role in the company! The IRS scrutinizes S Corps where the owner takes a very low salary and high distributions to avoid payroll taxes. Based on your $475k profit, your $140k salary might actually be reasonable, but it depends on your industry and personal role. If you're the primary service provider or a specialized professional, the IRS might expect your salary to be higher relative to distributions.

Don't forget state taxes too! The federal pass-through treatment is just part of the equation. Some states follow federal S Corp treatment, but others have additional taxes at the entity level. I'm in California where we have a 1.5% tax on S Corp income at the business level IN ADDITION to the pass-through income being taxed on my personal return. Cost me thousands extra I wasn't expecting my first year!

From your description, sounds like you might have a reasonable salary already. But another advantage of S Corp status you should be taking advantage of - the pass-through income isn't subject to self-employment tax (15.3% between Social Security and Medicare). That's a huge savings compared to running the same business as a sole proprietorship where ALL your profit would face SE tax. That's why the salary vs. distribution balance matters so much. You need to pay FICA taxes on your salary, but not on distributions. Just don't go too low on salary or you'll raise red flags.

One thing that might help clarify this for you - think of your S Corp as essentially "transparent" for tax purposes. The IRS basically pretends it doesn't exist when calculating your personal taxes. Your $140k salary gets reported on your W-2 and taxed as regular wages. The remaining $335k gets reported on Schedule K-1 and flows to your personal return as pass-through income. Then your TOTAL income ($475k plus any other personal income) determines which tax brackets apply to different portions. So yes, most of your income will likely fall into higher brackets, but remember that tax brackets are marginal - you don't pay 37% on all $475k, just on the portion that exceeds the 37% bracket threshold. Also definitely look into that QBI deduction mentioned earlier - as a design business, you should qualify for up to 20% deduction on the pass-through portion, which can significantly reduce your effective tax rate on that $335k. Just make sure your total taxable income doesn't push you into the phase-out ranges where the deduction gets limited.