Income from an S corporation and income from a general partnership Flashcards
Why Income from an S corporation from Schedule K-1 is not consider net earning from self-employment but income from general partnership is consider net earning from self-employment ?
S corporation and income from a general partnership are treated differently for self-employment tax purposes because of the nature of the roles and the tax rules governing these entities.
General Partnership
If you are a general partner in a partnership, you are considered actively involved in the business operations. This means the income you receive is treated as compensation for your work and is subject to self-employment tax. Self-employment tax includes Social Security and Medicare taxes, which are typically paid by both employees and employers. Since you are essentially both the “employer” and “employee” in this case, you pay the full self-employment tax on your share of the partnership’s income.
S Corporation
In an S corporation, you are a shareholder, not a partner. Shareholders are considered investors in the business, not active participants in the same way as general partners. Income from an S corporation is passed through to shareholders and reported on Schedule K-1, but it is not subject to self-employment tax. Instead, if you work for the S corporation, you would receive a salary, which is subject to payroll taxes (Social Security and Medicare). The remaining income distributed to you as a shareholder is considered a return on investment and is not subject to self-employment tax.
Key Difference
The distinction lies in the role you play:
General Partner: Actively involved in the business, so income is treated as earned income and subject to self-employment tax.
S Corporation Shareholder: Treated as an investor, so income is not considered earned income for self-employment tax purposes. However, if you work for the S corporation, your salary is subject to payroll taxes.
This difference reflects the tax system’s attempt to distinguish between active work (subject to self-employment tax) and passive investment income (not subject to self-employment tax).
