Which of the following best describes how S-Corporation profits are taxed to owners?

• A. Dividend income only
• B. Payroll and/or dividends
• C. Retained earnings taxed at corporate level
• D. Interest income

Answer: (B)

S-Corporation profits are taxed to owners through a pass-through method. The company itself generally pays no income tax on its profits. Instead, profits flow to the owners and are taxed on their personal tax returns. part of that tax comes from compensation paid to owners for services, which is treated as payroll wages and subject to payroll taxes. The remaining profits are passed through to owners and taxed as distributions (often described as dividends) on their individual tax returns. Because there’s no corporate tax at the entity level, the overall tax impact to the owners comes from payroll wages plus the owners’ share of the pass-through income. This is why the best description is payroll and/or dividends.