Choosing to qualify your small-business corporation under Subchapter S of the federal tax code affects the way you distribute profits to shareholders. The Internal Revenue Service requires S corporations to allocate profits and losses to individual shareholders every year for tax purposes. If you don't handle annual S corporation allocations and distributions properly, you risk losing the company's favorable Subchapter S tax status.

Pass-Through Taxation

An S corporation is a business incorporated under state law that has made an election with the IRS to be taxed as a pass-through entity, just like a partnership. This election enables the shareholders to avoid double taxation, where corporate profits are taxed once at the entity level when the corporation files its annual tax return and again at the individual level when the corporation distributes net profits to shareholders as dividends. Unlike a regular corporation, an S corporation isn't considered a taxpayer and doesn't pay entity-level taxes. Instead, it passes profits and losses through to its shareholders, and they pay taxes on their proportionate amounts at their individual tax rates.

Profit and Loss Allocations

S corporations are required by the IRS to allocate profits and losses to shareholders every year. By the end of the year, all business profits and losses must be assigned to the shareholders on a per-share basis so that the amounts can be included with each shareholder's individual income tax return. Although profits and losses must be allocated annually, the authorization and timing of distributions are determined by the company's board of directors. In practice, it's possible that shareholders will have to pay taxes on business profits in a year that the board does not authorize those profits to be distributed. For example, this could happen if the profits are needed for a major business expansion.

Profit Distributions

An S corporation can distribute allocated profits once a year or at any regular interval. The board of directors must vote and pass a resolution to distribute profits, setting the date for the distributions. Typically, distributions are authorized in quarterly, bi-annual or annual payments. Payment is authorized on a per-share basis, with each shareholder receiving the same amount per share. The tax code restricts S corporations to one class of stock, so a shareholder's distribution is based on the number of shares held rather than on preferential treatment for holding a higher class of stock. The S corporation issues a distribution check to each shareholder based on the board's resolution.


Properly handling distributions to shareholders is a major imperative. Mishandling distributions can result in the IRS terminating the S corporation's favorable tax status, which can have dire tax consequences for the corporation and its shareholders. A qualified accountant can help you keep track of profits and losses, file the corporation's IRS Form 1120S tax return, distribute Schedule K-1 to shareholders informing them of their allocated shares and cut the checks to distribute profits.