Which of the following describes how the income of an S corporation is treated for tax purposes?

• A. Taxed at both the corporate and individual level
• B. Only taxed at the individual level
• C. Only taxed at the corporate level
• D. Exempt from tax

Answer: (B)

The treatment of S corporation income for tax purposes is distinctive as it is designed to avoid the double taxation that typically applies to C corporations. In an S corporation, the income, deductions, and credits are passed through directly to the shareholders. This means that the corporation itself does not pay corporate income tax. Instead, the shareholders report their respective shares of the income on their individual tax returns and pay income tax at their personal income tax rates.

This pass-through taxation allows the income of an S corporation to be taxed solely at the individual level, reflecting the benefit of the structure intended to promote small business growth and investment. The shareholders thus receive the income reported via their K-1 forms, which detail their share of the corporation's income, deductions, and credits for the year. This method is in stark contrast to the treatment of C corporations where profits are taxed at the corporate level first, and then again at the individual level when dividends are distributed.

In summary, the S corporation’s income is treated only at the individual level for tax purposes because it allows for a single layer of taxation on the income passed through to shareholders, aligning with the goal of simplifying tax burdens on small business owners.