Being taxed as an S Corporation certainly has its advantages.

That’s something you may hear quite often, but what does that actually mean?

Let’s take a look at two simplified examples:

Example 1:

You have a sole proprietorship, you receive $100,000 in income. How is that taxed?

There is a self-employment tax of 15.3% on the $100,000 ($15,300.00).

That $100,000 is also subject to income tax.

Example 2:

Now let’s say you have a company that is being treated as an S Corporation. Company receives $100,000 in income. How will that get taxed?

Assuming $50,000 of that $100,000 goes to you as salary and the other $50,000 as a distribution, you pay your payroll tax (also happens to be 15.3%) on the $50,000 salary ($7,650)

That remaining $50,000 distribution is subject to income tax.

Conclusion:

You save potentially a lot of money in taxes from having a company that elects to be treated as an S Corporation. There are some other limitations on this scenario but these are the basic principles when one refers to the Self Employment Tax Shield i.e. a shield against having to pay high self-employment taxes.