What Equity Accounts Should I Have for an S-Corp With Two Partners?

By Jeff Clements

Unlike a C corporation, whose earnings are taxed at the corporate level, an S corporation is a small business corporation that is taxed as a disregarded entity. Its earnings flow through to its shareholders and are taxed at the individual level. Its individual owners make initial capital contributions and can receive corporate distributions throughout the life of the business.

Accounting Systems

Generally, the accounting for an S corporation is the same as that for a regular C corporation. However, while certain equity accounts of an S corporation and a C corporation are the same, their definition is different due to the disparate tax treatment of each entity.

Equity Accounts

Regardless of the number of owners, an S corporation should have four main equity accounts for each, including common stock issued at par (nominal) value, additional paid-in capital (APIC), distributions paid out to shareholders, and retained earnings. Common stock and APIC together represent the total capital invested in the corporation by each shareholder. These accounts are distinct although the par or nominal value of shares has no practical effect in this situation. Nonetheless, each owner should have his own account for APIC and distributions paid to track that individual owner's total capital contributions and net distributions.

Ready to incorporate your business? Get Started Now

S Corporation vs. C Corporation

An S corporation can have only one class of stock, so the C corporation's equity account that would otherwise track both preferred and common stock is effectively only a common stock account for an S corporation. Likewise, an S corporation doesn't technically pay dividends. As a pass-through entity, it instead allocates its profits and losses to owners, so what would otherwise be called dividends are distributions of earnings and profit. Also, an S corporation's retained earnings equity account is not identical to the retained earnings account of a C corporation. Since a C corporation is taxed on its earnings at the corporate level, its retained earnings account reflects after-tax money that the corporation holds onto instead of paying out as dividends. In contrast, an S corporation's retained earnings account is pre-tax money that has been allocated to owners but not distributed.

Account Adjustments

As a result of these differences, if an S corporation is changed back into a C corporation, you cannot simply keep using these equity accounts as if they mean the same thing under an S corporation tax structure as they do under a C corporation tax structure. There would need to be complicated calculations and adjustments in order to reconcile the accounts to reflect the proper tax-adjusted balances.

Ready to incorporate your business? Get Started Now
How Are Profits Split in an LLC?

References

Related articles

How Do Capital Accounts in LLCs Work?

An LLC's capital accounts allow the company to maintain an accurate accounting of each member's contributed cash or property: They are "running totals" of the members' ownership and investment. When forming a limited liability company, each member contributes a certain amount of cash or real property to the company. Often, although not necessarily, the amount each member contributes at the beginning forms the basis for his ownership. If two LLC members each contribute $50,000 to start a business, they will typically each own 50 percent of the business. Periodically, capital accounts are adjusted up or down to reflect profits or losses to the business, in accordance with each member's ownership and the terms of the operating agreement.

How Much Should I Pay Myself From My Corporation?

An owner's decision regarding how much salary to take from a business is generally a private management decision for closely held corporations — corporations where half of the shares are held by five or fewer shareholders — that are not publicly traded. However, the decision is affected by potential tax consequences.

How to Change the Shareholders' Percentage in an S-Corporation

An S-corporation is a flow through tax entity; its shareholders are taxed on their shares of the business’s income and losses, while the business itself does not have to pay income tax. A shareholder’s percentage in any corporation is the amount of shares she owns divided by the total number of shares outstanding. Therefore, to change a shareholders’ percentage, you must adjust how many shares the shareholder controls, or adjust the amount of outstanding stock.

LLCs, Corporations, Patents, Attorney Help

Related articles

Sole Proprietorship & Retained Earnings

Small business owners that organize as sole proprietorships enjoy fairly simple accounting and tax-paying chores. Like ...

How to Remove a Shareholder From an S-corp

While an S corporation functions like a C corporation, it is taxed differently. Each shareholder pays taxes on his ...

Distributions to LLC Members Vs. Dividends

Members of a limited liability company, or LLC, and the shareholders of a corporation are similar in that they each ...

Tax Consequences of Converting a C-Corp to an S-Corp

Corporations are business entities formed under state law that exist separately from their owners. An S corporation is ...

Browse by category
Ready to Begin? GET STARTED