S Corp Taxes in Lexington Kentucky 2026: A Complete Tax Strategy Guide for Business Owners

For the 2026 tax year, Lexington, Kentucky business owners are discovering that S Corporation taxation can deliver substantial tax savings. Unlike traditional C Corporations or sole proprietorships, S Corps offer a unique advantage: the ability to split business income between W-2 wages and distributions, potentially reducing self-employment taxes by thousands of dollars annually. However, understanding how S Corp taxes work requires careful attention to IRS rules, particularly the critical requirement for reasonable compensation. This guide provides everything Lexington entrepreneurs need to know about S Corp taxation strategy for 2026.

Table of Contents

• Key Takeaways
• What Are S Corp Taxes in Lexington, Kentucky?
• How Does S Corp Taxation Differ from Other Business Structures?
• What’s the Difference Between S Corp Salary and Distributions?
• How Much Can You Save With S Corp Tax Planning?
• What Does the IRS Consider Reasonable Compensation?
• What Are S Corp Filing Requirements in Kentucky?
• Uncle Kam in Action: Lexington Business Success
• Next Steps
• Frequently Asked Questions
• Related Resources

Key Takeaways

• Self-employment tax savings: S Corps can save business owners 15.3% on income distributed as profits (after reasonable salary).
• Two-tier income strategy: Split income into W-2 wages (subject to self-employment tax) and distributions (not subject to self-employment tax).
• Reasonable salary requirement: IRS requires shareholder-employees to pay themselves a reasonable salary for services rendered.
• Kentucky advantages: Combined federal and Kentucky state tax rates for 2026 create additional planning opportunities.
• Quarterly requirements: S Corps must file quarterly estimated taxes and maintain payroll compliance.

What Are S Corp Taxes in Lexington, Kentucky?

An S Corporation is not a business entity type like LLC or sole proprietorship. Instead, it’s a tax election. Your Lexington business can be structured as an LLC, C Corporation, or sole proprietorship, but you can elect S Corp taxation status with the IRS using Form 2553.

When you make an S Corp tax election for your lexington s corp taxes, the IRS treats your business as a pass-through entity. This means business income passes through to your personal tax return rather than being taxed at the corporate level. You avoid the “double taxation” problem of traditional C Corporations.

How S Corp Taxation Works

For the 2026 tax year, when you operate an S Corp in Lexington, Kentucky, your business reports income on Form 1120-S. This form shows business income, deductions, and credits. At year-end, you receive a Schedule K-1 showing your share of profits and losses.

The critical difference between S Corps and sole proprietorships emerges with self-employment taxes. As a sole proprietor, you pay self-employment tax on all net business income at a rate of 15.3% (12.4% Social Security plus 2.9% Medicare). With an S Corp, you only pay self-employment tax on W-2 wages you pay yourself.

Kentucky-Specific Considerations

Lexington, Kentucky business owners benefit from Kentucky’s 3.5% state income tax rate for 2026 (reduced from 4% in 2025). This flat state tax applies to S Corp income whether paid as wages or distributions. Combined with federal taxation, understanding your effective tax rate is essential for strategic planning.

How Does S Corp Taxation Differ from Other Business Structures?

Comparing lexington s corp taxes to other structures reveals why many Lexington entrepreneurs choose S Corp taxation. The differences impact your bottom line significantly, particularly as business income grows.

S Corp vs Sole Proprietorship

As a sole proprietor, you report all business income on Schedule C of your Form 1040. You pay self-employment tax on net business profit at 15.3%. There’s no separation between income and self-employment tax liability.

With S Corp status, you split income strategically. You pay yourself a reasonable W-2 salary (subject to self-employment tax) and distribute remaining profits as dividends (not subject to self-employment tax). This creates substantial tax savings on distributions.

S Corp vs LLC

An LLC is a business structure offering liability protection. By default, the IRS taxes single-member LLCs as sole proprietorships and multi-member LLCs as partnerships. However, an LLC can elect S Corp taxation for federal purposes.

Many Lexington business owners form an LLC for liability protection, then elect S Corp taxation to achieve self-employment tax savings. This combination provides the best of both worlds.

What’s the Difference Between S Corp Salary and Distributions?

The salary vs distribution split is the cornerstone of S Corp tax strategy. Understanding how each is taxed is essential for optimizing your lexington s corp taxes.

S Corp Salary (W-2 Wages)

When you pay yourself an S Corp salary, you issue yourself a W-2 Form just like any other employee. The salary is subject to:

• Federal income tax withholding (based on your Form W-4)
• Social Security tax at 6.2% (you and employer each pay)
• Medicare tax at 2.9% (you and employer each pay)
• Kentucky state income tax at 3.5% for 2026

The S Corp must file payroll taxes quarterly using Form 941 and pay payroll processing costs, but this is the price of accessing self-employment tax savings.

S Corp Distributions

Distributions represent profit remaining after you’ve paid yourself a reasonable salary. These distributions are NOT subject to self-employment tax, though they are subject to income tax.

For Lexington, Kentucky S Corp owners, distributions bypass the 15.3% self-employment tax entirely. You only pay federal income tax (your marginal rate) plus Kentucky’s 3.5% state tax.

If you’re in the 24% federal bracket plus 3.5% Kentucky tax, distributions are taxed at 27.5% total, versus 39.3% on self-employment income (15.3% SE tax plus 24% income tax).

How Much Can You Save With S Corp Tax Planning?

Calculating your specific savings requires understanding your tax situation. Let’s walk through a realistic example for a Lexington business owner.

Lexington S Corp Tax Savings Example

Scenario: A Lexington marketing consultant generates $150,000 in annual business income. Currently operating as a sole proprietor, she pays self-employment tax on all income.

Current (Sole Proprietor):

• Net business income: $150,000
• Self-employment tax (15.3%): $22,950
• Federal income tax (24% bracket): $36,000
• Kentucky state tax (3.5%): $5,250
• Total tax: $64,200

With S Corp Taxation:

• Reasonable salary: $100,000
• Payroll taxes on salary: $15,300
• Distributions: $50,000
• Federal income tax: $36,000
• Kentucky state tax: $5,250
• Total tax: $56,550

Annual Savings: $7,650 (12% reduction in total tax liability)

These estimates account for 2026 tax brackets, payroll processing costs ($500-$1,200 annually), and S Corp filing fees ($100-$300). The break-even point for S Corp taxation is typically around $60,000-$75,000 in annual business income.

What Does the IRS Consider Reasonable Compensation?

The IRS doesn’t publish specific salary guidelines for S Corps. Instead, they examine each business individually using the “reasonable salary” standard. For Lexington entrepreneurs, this requires documenting your services and market comparables.

IRS Factors for Reasonable Salary

The IRS considers these factors when evaluating S Corp shareholder salaries:

• Time and effort: How many hours does the shareholder work? What are their responsibilities?
• Skills and expertise: What education, licenses, and professional qualifications do they have?
• Dividends paid: Does the company distribute profits as dividends or reinvest them?
• Economic conditions: Is the business thriving or struggling in its market?
• Industry practices: What do similar positions pay in the same industry and location?
• Company size and complexity: Is this a one-person startup or a mature organization?

Documentation Matters for Audit Defense

If the IRS audits your S Corp, you’ll need evidence that your chosen salary is reasonable. Maintain:

• Job descriptions detailing your role and responsibilities
• Industry wage data from Bureau of Labor Statistics or compensation surveys
• Business financial statements showing profitability and dividend history
• Board minutes documenting salary decisions (even if you’re the only owner)
• Comparison salaries for similar positions in your geographic area

For a Lexington consultant or service provider, reasonable compensation often ranges from 50-80% of business net income, with distributions making up the remainder. The exact percentage depends on your specific situation.

What Are S Corp Filing Requirements in Kentucky?

Operating an S Corp requires staying organized with tax filings. Unlike a sole proprietorship, S Corps have specific administrative and compliance obligations.

Federal S Corp Tax Filing

Each year, your S Corp must file Form 1120-S (U.S. Income Tax Return for an S Corporation) by March 15 (or your extended deadline if filing an extension). This form reports all business income, deductions, and distributions to the IRS.

Additionally, you’ll receive a Schedule K-1 showing your share of income, loss, credits, and deductions. You report this on your personal tax return using Form 1040.

Payroll Tax Requirements

Because S Corps must pay reasonable salaries, payroll compliance is mandatory. You must:

• File quarterly Form 941 (Employer’s Quarterly Federal Tax Return)
• Pay federal payroll taxes by deposit deadlines (semi-weekly or monthly)
• File Kentucky Department of Revenue Form KY-941 for state payroll taxes
• Issue W-2 forms to yourself and any employees by January 31 each year
• File annual Form 940 (Employer’s Annual Federal Unemployment Tax Return)

State of Kentucky Requirements

Kentucky requires S Corp filers to submit Kentucky Form 720S along with their federal return. This form shows Kentucky-source income and is used to calculate your Kentucky state tax obligation. Lexington businesses must also maintain a current business license with the City of Lexington.

For professional service providers (consultants, attorneys, accountants), Kentucky may require additional licenses or registrations depending on your industry.

Uncle Kam in Action: A Lexington Software Developer Saves $9,200 Annually

Client Snapshot: James is a software developer in Lexington, Kentucky, operating as a sole proprietor. He generates $200,000 in annual revenue with $180,000 in net business income after expenses.

Financial Profile: Age 42, married filing jointly, with a spouse earning $65,000 W-2 income. Combined household income places them in the 24% federal tax bracket for 2026.

The Challenge: James was frustrated with his tax bill. As a sole proprietor, he paid self-employment tax on his entire $180,000 business income. His annual self-employment tax alone was $27,540 (15.3% of $180,000). After federal income taxes and Kentucky state tax, his combined tax burden exceeded $65,000 annually—over 36% of his income.

The Uncle Kam Solution: We recommended converting his sole proprietorship to an LLC taxed as an S Corporation. James formed a Lexington-based LLC and made the S Corp election using Form 2553. We documented his reasonable salary by researching software developer compensation in Kentucky’s Lexington metro area ($110,000-$130,000 for similar roles and experience).

We established his S Corp compensation strategy: $120,000 annual salary (W-2 wages) and $60,000 in distributions. This allocation:

• Paid him market-rate compensation for his services
• Subjected $120,000 to payroll taxes (15.3% = $18,360)
• Distributed $60,000 profit free from self-employment tax
• Reduced total self-employment tax from $27,540 to $18,360

The Results:

• Tax Savings: $9,180 annually (self-employment tax reduction)
• Investment: One-time setup cost of $1,500 (LLC formation, S Corp election, initial tax planning)
• Return on Investment (ROI): 6.12x return in the first year alone, plus ongoing savings in future years

This is just one example of how proven tax strategies have helped clients achieve significant savings. James now reinvests his tax savings into professional development and business growth.

Next Steps

If you’re operating a business in Lexington, Kentucky and want to optimize your lexington s corp taxes, here are your action items:

• Calculate your break-even: Review your current business income and tax rate. Most businesses over $75,000 in annual profit benefit from S Corp taxation.
• Research salary benchmarks: Document what similar positions pay in Lexington using Bureau of Labor Statistics data or industry surveys.
• Understand Kentucky requirements: Review Kentucky Department of Revenue S Corp regulations and business licensing requirements for your specific industry.
• Consult a tax professional: Before implementing S Corp taxation, discuss your specific situation with a qualified tax advisor in Lexington who understands local requirements. Uncle Kam provides specialized S Corp tax preparation services for Lexington business owners to ensure full compliance.
• Plan your transition: If switching from sole proprietor to S Corp, timing matters. Consider mid-year elections versus January 1 elections based on your cash flow.

Frequently Asked Questions

Can I elect S Corp status if I just started my business in Lexington?

Yes, you can make an S Corp election immediately after forming your business entity. However, the tax benefits work best after you’ve established a track record showing reasonable profitability. The IRS looks for businesses with consistent profits to validate S Corp elections.

What happens to my 2026 401(k) contributions as an S Corp owner?

As an S Corp shareholder-employee, you can still contribute to a 401(k) up to the 2026 limit of $24,500 if your S Corp sponsors a plan. Your employer (the S Corp) can also make matching contributions. However, self-employed SEP-IRA contributions work differently—you calculate them on your S Corp net profit, not just W-2 wages.

Will the IRS audit my S Corp if I claim significant tax savings?

Not necessarily. The IRS doesn’t audit based on tax savings alone. However, if your salary appears unreasonably low compared to your distributions, you increase audit risk. Maintaining proper documentation of your salary decision and industry comparables significantly reduces risk. The key is demonstrating that your chosen salary is defensible.

Can I deduct business expenses the same way with S Corp status?

Yes. S Corps deduct the same business expenses as sole proprietors: office supplies, equipment, vehicle costs, professional development, health insurance, and more. The main difference is where the income appears—on Schedule C for sole proprietors versus Form 1120-S for S Corps—but deductions remain substantially the same.

What’s the cost of maintaining an S Corp in Lexington, Kentucky?

Annual S Corp costs include: payroll processing ($500-$1,200), professional tax preparation ($500-$1,500), Kentucky business license renewal ($10-$50), federal S Corp Form 1120-S filing fee ($0), and Kentucky Form 720S filing fee ($0). Total: approximately $1,000-$2,750 annually. This cost is easily offset by tax savings for most businesses.

Can I change my S Corp election if I decide it’s not right for me?

Yes. You can revoke your S Corp election using IRS Form 2553, Section 338. However, timing matters for tax purposes. Revoking mid-year can create complex tax situations. It’s best to coordinate revocation timing with your tax professional to minimize disruption.

How does S Corp taxation change if I have employees besides myself?

Having employees doesn’t fundamentally change S Corp taxation, but it increases payroll complexity. You must process payroll for all employees, withhold taxes, and file quarterly payroll reports for each person. The self-employment tax savings logic remains the same—distributions to shareholders still avoid self-employment tax, while W-2 wages for all employees (including yourself) are subject to payroll taxes.

Related Resources

• Entity Structuring Guide: Choosing the Right Business Structure
• Comprehensive 2026 Tax Strategy Services for Business Owners
• Tax Planning Solutions for Business Owners in All Industries
• IRS Official S Corporation Information and Forms
• Kentucky Department of Revenue: Business Tax Information

Last updated: January, 2026