S-corp basics
An S-corp is a domestic corporation (or LLC electing corporate status via Form 8832) that has filed Form 2553 to be taxed under Subchapter S of the Internal Revenue Code. The S-corp is generally not subject to entity-level income tax — instead, income, losses, deductions, and credits flow through to shareholders via Schedule K-1.
Why small businesses elect S-corp
The most common reason is payroll tax savings: an S-corp owner pays Social Security and Medicare tax only on the W-2 wages they take from the company, not on the additional pass-through profit. The savings can be substantial once profit comfortably exceeds a reasonable salary, but the cost of payroll, more complex bookkeeping, and additional state filings often outweighs the benefit until profit reaches $50,000-$75,000+.
Reasonable compensation
The IRS requires S-corp owner-employees to pay themselves "reasonable compensation" before taking distributions. There is no bright-line test, but factors include duties performed, time devoted, comparable salaries, training, and what an arm's-length employer would pay. Failure to take reasonable compensation is a top S-corp audit issue and can result in re-characterization of distributions as wages, with back payroll taxes and penalties.
Form 1120-S timing
Form 1120-S is due March 15 for calendar-year S-corps, with a six-month extension to September 15 available via Form 7004. Schedule K-1 must be furnished to shareholders by the extended due date. Late filing carries a per-shareholder, per-month penalty.
Built-in gains and excess passive income
S-corps that converted from C-corp status can owe entity-level tax on built-in gains during a five-year recognition period, and on excess passive investment income if accumulated earnings and profits remain from the C-corp years. Newly formed S-corps generally do not face either tax.
Penalties for late or missing filings
Late or missing filings of Form 1120-S, U.S. Income Tax Return for an S Corporation draw distinct penalties depending on the form: failure-to-file (5% per month, capped at 25%), failure-to-pay (0.5% per month), failure-to-deposit for payroll forms (graduated based on lateness), failure-to-file information returns (per-return penalty that scales with size and lateness), and accuracy-related penalties (20% of underpayment for negligence or substantial understatement). The dollar amounts are not trivial. Calendaring the form's deadline, setting up an electronic reminder a week in advance, and using a payroll or tax-prep service that auto-files are the cheapest defenses against accidental late filings.