As a shareholder-employee, your S corporation pays you a salary for the work you perform. It can also make distributions of earned income or incurred losses. One significant difference between the two is that the S corporation must withhold payroll taxes from your salary. Your S corporation does not withhold taxes on distributions. Instead, the tax liability flows through the S corporation to you. You report the distribution on your personal income tax return.
Stock Basis
The amount of your S corporation distribution depends on your stock basis. Your beginning stock basis is the initial capital or property you contribute to your S corporation in exchange for stock. If you contribute $10,000 in capital, your initial stock basis is $10,000. If you pay for the stock outright, the full purchase cost is your beginning stock basis. The stock basis also determines how much of your distribution is tax free.
Stock Basis Adjustments
Your stock basis should be adjusted periodically so your distribution can be accurately calculated. If your stock basis increases, you can receive a larger distribution. The income your S corporation earns, except for tax-free income, and additional capital contributions you make increase your stock basis. Likewise, if your stock basis decreases, your distribution amount is reduced. S corporation distributions of cash and property, as well as nondeductible expenses, reduce your stock basis.
Distributions in Excess of Basis
No taxable event occurs as long as your distribution does not exceed your stock basis. If it does, your distribution is divided into the taxable and nontaxable amount. The Internal Revenue Service considers the amount that exceeds your stock basis as a capital gain. You must report it on Schedule D and on your personal income tax return. If your S corporation has a loss, you must carry the amount forward that exceeds your stock basis.
Avoiding Distribution Reclassification
The IRS looks hard at S corporation distributions to make sure they are not recharacterized wages. To prevent distributions from being reclassified as wages, record each distribution in the corporate record. All shareholders should receive a distribution on the same date and in proportion to their stock ownership. Record the name of each shareholder and the dollar amount of the distribution. Decide how many times per year you want to make distributions -- for example, monthly or semimonthly -- and try to keep to that schedule. If you do not have enough money or retained earnings for a distribution, make the distribution on the next scheduled date.
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Writer Bio
Based in St. Petersburg, Fla., Karen Rogers covers the financial markets for several online publications. She received a bachelor's degree in business administration from the University of South Florida.