ACE Personal Trainer Practice Exam

What distinguishes an S-Corporation regarding taxation?

1. Dollars are taxed at the corporate level only

2. It is not subject to federal taxes

3. Income/losses are passed through to shareholders

4. Only shareholders pay income taxes on corporate gains

The correct answer is: Income/losses are passed through to shareholders

An S-Corporation is a unique entity in the realm of business taxation because it allows for the income and losses of the corporation to be passed directly to the shareholders. This means that rather than the S-Corporation itself being taxed on its earnings, the income is reported on the individual tax returns of the shareholders, and they pay tax on that income at their personal income tax rates. This pass-through taxation is beneficial as it helps avoid the double taxation that often occurs with traditional C-Corporations, where income is taxed at both the corporate level and again when distributed as dividends to shareholders. In regard to the other options, it’s important to note that while S-Corporations are not directly taxed at the corporate level, they still must meet specific qualifications and file with the IRS to maintain their status. Therefore, saying that it is "not subject to federal taxes" might misrepresent the nature of S-Corporations since they have certain tax obligations such as payroll taxes. Similarly, although only shareholders pay taxes on their individual returns, this doesn't fully capture the essence of how S-Corporations operate in terms of taxation.