The owners of an S corporation can choose to retain earnings to grow the value of the company and each shareholder's holdings, or distribute the income to shareholders in the current year. The income may be distributed as wages, dividends or bonuses. Each method has benefits and drawbacks, so you may want to consult an attorney or tax accountant to review your options before making any final decisions.

Bonus Payments

Because the key shareholders usually double as officers in an S corporation, distributing income as a bonus offers a certain degree of flexibility in setting the payment terms. Shareholders can choose to take a bonus in years when the company does well instead of changing the officers' salaries every year. Changes in officer salaries can trigger IRS investigation if they happen frequently. Bonus money usually is split by ownership percentage unless there are performance incentives in play for certain shareholders.

Taxation of Bonuses

The tax rate for individual shareholders is higher for bonuses than for regular salary payments. The impact of this depends on each shareholder's personal financial situation. Employment taxes such as FICA, Social Security and Medicare must be charged on bonus payments. The shareholder also will be taxed at the ordinary income rate on the bonus. Tax withholding on bonuses is calculated on an annual basis. If the shareholder's salary is low compared to the amount of a one-time bonus, the withholding on that bonus payment may be higher than necessary.

Dividend Payments

Dividends are not subject to employment taxes. It is classified as "non-earned income" and passed through to the shareholders on the company's Schedule K-1. Dividends also offer some discretion in determining payment amounts and frequency. For example, the company can choose only to pay dividends if it has excess cash on hand. The board of directors must declare the intent to pay dividends at an official meeting and prepare a written resolution documenting the details of the payment.

Dividend Reclassification

Dividend payments may trigger an IRS audit if they appear to be a method of circumventing employment taxes. The auditor will look at the percentage of the company's income paid out as dividends compared to the amount paid as wages. If it appears to be out of proportion when compared to other companies in your industry, the IRS can reclassify all or part of the dividend as wages. The S corporation will be liable for the employment taxes that should have been paid on the wages, along with any late fees, penalties and interest.