When Are S Corp Distributions Taxed?

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In the United States, eligible corporations that have elected to be taxed under Subchapter S of the Internal Revenue Code, are described as S Corporations. Typically, owners of S Corporations pay tax on the income or deductions of the S Corporation in the year it is earned, and no tax is paid upon distribution. Significant exceptions exist, however.

Basic

Many taxpayers believe S Corporations to be preferable to regular corporations as they avoid the double taxation that occurs when corporate income is first taxed on a corporate level, and then on an individual income tax level when dividends are paid to shareholders. In an S Corporation there is typically no taxation on a corporate level for federal tax returns. The income and deductions of the corporation are instead "passed through" to the individual shareholders and reported on their income tax returns.

Basis

A shareholder's basis in an S Corporation refers to the amount of money a shareholder has contributed to the corporation, plus any loans to the corporation. When a corporation without accumulated earnings and profits (generally historic gains and losses) distributes money or property to a shareholder in excess of the shareholder's basis, the amount of the distribution in excess of basis is taxable to the shareholder as a sale of the corporation's stock, a capital gain.

Example

Assume that Taxpayer A makes a $100 capital contribution to S Corporation B. Subsequently, Taxpayer A makes a personally guaranteed loan of $50 to S Corporation B. Taxpayer A's basis in S Corporation B is now $150. If S Corporation B now makes a $160 distribution to Taxpayer A, $150 of the distribution will typically be non-taxable; however, $10, the excess of the distribution over basis, is taxable to Taxpayer A as a capital gain.

Earnings and Profits

When a corporation has historical earnings and profits, the amount of these gains and losses are added to or subtracted from basis in determining the taxable amount of an S Corporation distribution. In general, income recognized from an S Corporation is added to the shareholder's basis, and losses recognized from an S Corporation are used to reduce the shareholder's basis for purposes of determining the taxable amount of distributions.

1120S K-1

The income and deductions from an S Corporation is reported to the shareholder via an Internal Revenue Form known as an 1120S K-1. This form can be used by the shareholder to not only calculate the shareholder's taxable share of the S Corporation's activities, but may also be used to track basis items, including non-deductible expenses such as certain meals and entertainment or officer life insurance costs. Schedule 1120S K-1 does not track the entire basis of the shareholder, however, and the shareholder may need to keep independent records.