Accounting For S Corp: Everything You Need to Know
Accounting for S corp is important to understand completely as you should have a robust accounting method in place for your business. 4 min read
2. Common Stock and Additional Paid-In Capital Accounts
3. Distributions Paid to the Shareholders Account
4. Retained Earnings Account
5. Tax Basis for S Corp
Accounting for S Corp
Accounting for S corp is important to understand completely as you should have a robust accounting method in place for your business. Most importantly, you should know that an S corporation is referred to as a flow-through entity, meaning the money flows through the corporation and onto the owners and shareholders. Because of that, the corporation is not taxed at all. Rather, the owners and shareholders must report such profits and losses on their personal tax returns. The amount in which each owner must report is limited to the amount of capital that he or she invested in the business.
The accounting system for an corporations">S corp is generally the same as for a C corporation; however, since there are differences in tax treatment, the accounting can be a bit different. Specifically, an S corporation should have 4 main equity accounts, including:
• Common stock, which is issued at a nominal value
• Additional paid-in capital
• Distributions paid to the shareholders
• Retained earnings
Common Stock and Additional Paid-In Capital Accounts
Common stock, along with additional paid-in capital, represents the total amount of capital that was invested into the business by each shareholder. While both accounts represent the same item, they are unique from one another due to the fact that each shareholder should have his or her own account for stock and another for the additional paid-in capital.
Notably, while the C corp would have two separate stock accounts – one for common stock and another for preferred stock – the S Corp can only have one class of stock. Therefore, one common stock account will suffice.
Distributions Paid to the Shareholders Account
Technically speaking, an S corp doesn’t pay dividends since the profits and losses of the corporation are passed on to the owners. Therefore, instead of referring to this account as ‘distributions,’ S corps refer to it as ‘distributions of earnings and profit.’
Retained Earnings Account
Unlike the C corporation’s retained earnings account, the S corp account here is pre-taxed money that has been allocated to the owners, but not distributed. C corporations, however, have this account to reflect the after-tax money that the corporation holds onto instead of paying out the dividends to the shareholders.
Due to these differences, if the S corp wishes to revert back into a C corp, the same retained equity account cannot continue being used. Additional calculations would need to be made in order to reconcile the accounts to reflect the proper balance.
Based on the complexity of such tax issues regarding S corps, it is important for these businesses to maintain accurate records in terms of the business's operations, including expenses, income, capital investments, and the like. Moreover, the corporation must keep records of all shareholder investments; this can include cash or property investments. Since all money is passed through to the owners and shareholders to the extent of what they have invested in terms of capital, the accounting method must be up-to-date to prevent any issues down the line.
Tax Basis for S Corp
The tax basis for S corps represents the total of the stock basis and loan basis (also referred to as the debt basis). For example, if you invest $20,000 in the corporation (receiving stock) and also loan the company $5,000, your tax basis is $25,000. The tax basis is then increased by certain pass-through items, i.e. net income, and then decreased by other pass-through items, i.e. losses and deductions.
When calculating your tax basis, you must calculate your overall tax basis by using the stock basis first (the number must be $0 or greater) and then calculating in your loan basis, which also must be $0 or greater. If we take the example above, let’s assume that, for the $20,000 you invested, you received 100 shares of stock. Now, assume that John also invested $20,000 receiving 100 shares of stock. While your tax basis is $25,000 (the investment plus loan), John’s tax basis is $20,000. At year end, the corporation has $50,000 of net income. You and John are each given $25,000 (since you both have 100 shares of stock). Therefore, both of you must report this money as net income. Now, both you and John have increased your stock basis to $45,000 ($20,000 plus the $25,000 distribution). Your tax basis is now $50,000 ($45,000 stock basis plus the $5,000 loan basis). John’s tax basis is $45,000, which is also equal to his stock basis, since he didn’t lend any money to the corporation.
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