When Are S Corp Distributions Taxed?

by Michael Dreiser; Updated September 26, 2017

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.

About the Author

Michael Dreiser started writing professionally in 2010. He is a certified public accountant with experience working for a large New York City accountancy and expertise in areas ranging from private equity taxation to investment management. He holds a Master of Business Administration in international finance from l’École Nationale des Ponts et Chaussées in Paris.

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