How to Report a Dividend to a Shareholder of an S Corp
Eligible corporations can elect special treatment under the tax law. Opting S corporation treatment allows corporations to avoid federal income tax at the corporate level, instead passing income and losses through to shareholders. Although S corporations do not owe federal income tax, they must file Form 1120S with the Internal Revenue Service as an informational return. Additionally, the corporation must complete a Schedule K-1 for each shareholder to report proportional shares of income and losses. Dividend distributions are reported separately on Form 1099-DIV.
When an S corporation pays out to one of its owners, the payment can take a number of forms. The payment could be wages paid to an owner-employee, which reduces the total amount of income earned by the corporation. Or a payment could be an owner distribution. Most owner distributions made by S corporations are considered nondividend distributions. If the S corporation had operated as a C corporation before making the election, it could also make dividend distributions.
Traditional C corporations pay out earnings and profits in the form of dividends. Owners must report the dividend as taxable unearned income. When a C corporation makes an S corporation election, the corporation must account for its earnings and profit balance the same as if it were still a C corporation. Any distributions from the account are reported as dividend distributions on Form 1099-DIV. While dividends are taxable to the shareholder, they do not adjust the shareholder’s basis in the stock.
Distributions other than employee wages and dividends from an S corporation require more complex accounting. To prevent owners from paying tax on corporate income twice, tax laws establish a series of adjustments to the owner’s basis in the stock. An owner’s tax basis in an S corporation increases as he pays tax on his portion of the income. Nondividend distributions reduce the basis, allowing the owner to recover his money with only one level of taxation.
Dividend distributions are reported on Form 1099-DIV, an information return. The corporation is responsible for preparing a Form 1099-DIV for each owner to whom it issued a dividend, and it must mail a copy to both the IRS and the shareholder. The form contains biographical information on the issuer and recipient of the dividend, as well as the dollar amount of the dividend. The IRS has strict penalties for failing to file Form 1099-DIV on time, which can go as high as $100 per form not filed. File copies with the IRS by the end of February to avoid penalties.