How Are Property Distributions From an S Corp Taxed?

By John Cromwell

S corporations are flow-through entities, so business income and losses are taxed at the shareholder level; the business pays no income tax. As a result, the taxes applied to property distributions are limited because the shareholder already paid taxes on the property when it was earned in prior years. What taxes a shareholder might be required to pay depends on the reasons he received the distribution, how much he has paid in taxes in prior years, and how many distributions he received from the S corporation in the past.

Wages and Distributions

Since an S Corporation is a small business, many shareholders perform work for the company that a hired employee would normally undertake. When a shareholder performs these types of tasks, the IRS expects that he will be paid reasonable compensation. If a shareholder is viewed as an employee of the business by the IRS and he receives no compensation other than property distributions, a portion of that amount will be taxed as ordinary income. The IRS is more likely to consider a shareholder an employee if he is an officer in the company, such as the CEO.

Reasonable Compensation

When deciding how much of a distribution should be classified as reasonable compensation, the IRS will consider the tasks that the shareholder-employee performed in relation to the business. If the majority of the corporation’s income was generated by the shareholder-employee’s services, then the majority of the distribution will be classified as wages. The IRS will also consider the administrative work that the shareholder-employee did for the business. This is especially relevant for corporate officers. In the case of administrative positions, the IRS will determine reasonable compensation for the shareholder-employee based on several factors, including the shareholder’s responsibilities, experience and what employees earn in similar positions at other businesses.

Ready to incorporate your business? Get Started Now

Shareholder Basis

A person’s stock basis in an S corporation reflects the shareholder’s after-tax interest in the business. The proper application of basis prevents investors from being taxed twice on their investment in an S corporation. To calculate a shareholder’s basis, you start with the original amount of your investment. This includes any cash or property you contributed to start the business. Next, you add any business income you paid taxes on in the past. Then you deduct the amount of any distributions you’ve taken in the past and any corporate losses and deductions you’ve claimed on your income tax returns in the past. What remains is your stock basis in the business.

Distribution Taxation

Generally, any distribution received by an S corporation shareholder is not taxed. First, you subtract the amount from the distribution that was reclassified as wages. The wages portion will be taxed as earned income. If what remains is greater than your current basis in the business, that difference is taxable. The distributions that exceed the basis are normally taxed as a long-term capital gains.

Ready to incorporate your business? Get Started Now
The Basis in an S Corporation

References

Related articles

S Corporation Passive Income Restrictions

An S corporation is a corporation consisting of 100 or fewer shareholders that has a special tax designation granted by the IRS. While this designation offers the shareholders certain tax benefits, it requires the company to adhere to several restrictions and conditions. One of these restrictions involves how much passive income the business earns. It is important for an S corporation to closely monitor how much passive income it earns to ensure that it avoids any IRS penalties or tax repercussions.

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 share of the corporation’s income annually and has a capital account. So when a shareholder decides to surrender his ownership, the S-corp must ensures that all of the departing shareholder’s benefits are properly paid and ensure that he pays tax on his share of the corporation’s income during the period he owned S-corp.

What Forms Do I Need to File for an S Corp?

An incorporated business is automatically designated by the Internal Revenue Service as a C corporation for income tax purposes. However, certain smaller corporations can elect to be taxed as S corporations without forfeiting the liability protections that the corporate structure affords to shareholders. Making the initial election requires filing an IRS form. Once S corporation status is granted, the tax forms the corporation must file annually will change.

LLCs, Corporations, Patents, Attorney Help

Related articles

How Is Passive Income Taxable to an S Corporation Shareholder?

A chief benefit of being an S Corporation is that it allows the corporation’s shareholders to be taxed directly on all ...

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 ...

Do You Have to Pay Officer's Salaries Out of S Corporations?

One of the first decisions you must make when establishing your business is what structure your business will take. ...

An S Corporation's Board of Directors' Compensation Vs. a Shareholder Distribution

An S corporation is a "pass through" entity, and is taxed under the IRS code, Subchapter S. The corporation does not ...

Browse by category
Ready to Begin? GET STARTED