S Corp Distributions: Everything You Need to Know
S corp distributions are a crucial aspect that shareholders must be aware of.3 min read
2. Price of Mistakes
3. Understanding Codes
4. Shareholder Obligations
5. Adjustment Orders
6. Lowering Basis
S corp distributions are a crucial aspect that shareholders must be aware of. S corp shareholders who work for the corporation can classify themselves as employees and get the same tax benefits as other employees who are not shareholders. Such tax benefits include:
- Withheld taxes
- Withheld employment taxes
- Regular paychecks
Shareholders who do not work for the business should receive compensation based on any other work conducted. S corp shareholders may also take loans from the corporation. Further, promissory notes should be issued accordingly, and the note should including the lending terms. Such terms should mention:
- Fair market interest rates
- Promise to pay back the loan
- Repayment dates
Money that’s spent on business matters should be reimbursed by the business, and you should submit documentation supporting the disbursement to your account.
According to Section 1368, a disbursement of property or cash can create various possible tax repercussions to a shareholder:
- Distribution could result in a reduction that’s tax-free on a shareholder’s basis within a corporate stock
- Taxable dividends
- Gains from selling the stock (ending with capital gains)
The aforementioned options could result in all of the above, depending on the scenario. To understand the basic concepts of S corp distributions, you should conduct steadfast research to avoid possible consequences. The following concepts include:
- Shareholder attributes
- Stock basis
- Corporate attributes in the form of profits/earnings and accumulated adjustments
Price of Mistakes
The failure to understand the roles that each attribute plays in levying taxable distribution could add unnecessary complexities to the entire process and lead to mistakes.
The entire reasoning behind Section 1368 and other regulations is to retain vital differences between S and C corporations. Such distributions are made in areas pertaining to C corporate income in the form of profits and earnings, which must be taxed twice upon distribution, while S corp income is not taxed twice.
The varying distribution and attribute tiers of Section 1368 appear confusing at first, but pinpointing the intent behind the codes reveals the preservation between S and C corporate income as separate. In essence, it is a matter of understanding the varying codes involved.
Pursuant to Section 1367, a shareholder must annually adjust his basis in a stock to show the items of loss, income, gain, deductions, and distribution given to that shareholder. Such yearly adjustments preserve a single tax level that’s given to S corps.
According to Section 1367, the shareholder of an S corp must adjust annually his or her basis in the corporation’s stock to reveal items pertaining to:
- Income gains
- Distribution allocations to the shareholder
Such annual adjustments should be preserved on the single level of taxation given to S corps.
In addition, the shareholder should heighten an S corp basis stock for the following items:
- Capital contributions
- Separate stated income items (including income that’s tax-exempt) and non-divided computed income
- Excess deductions regarding depletion on the basis of property that’s open to depletion
Moreover, shareholders should lower basis for these items:
- Distributions aside from items taxed in the form of dividends under Section 1368
- Divided stated loss items, deductions, and non-divided computed losses
- Expenses that are nondeductible that may not be chargeable to capital accounts
You must take the order of adjustments into account. Although distributions reduce the basis, it is the stock basis of the shareholder that determines the taxability of distributions. Such regulations mandate the stock basis be adjusted first for the mandated increase to basis. Additionally, stock basis is lowered via distributions before loss reductions or nondeductible expenses.
As a general rule, basis is then lowered for nondeductible expenses, prior to being reduced for loss items and deductions.
Basis may not be lowered below zero. To the degree that losses surpass lingering stock basis after distribution deductions and non-deductible expenses, the loss excess may be levied to lower a basis that the shareholder has regarding the indebtedness of the S corp to a shareholder. In cases where losses exceed a shareholder’s basis regarding debt and stock, such losses are then suspended and could be carried ahead indefinitely.
To find out more about S corp distributions, submit your legal inquiry to our UpCounsel marketplace. UpCounsel’s lawyers will guide you through the intricacies of S corp dividends and the necessary adjustments you need to make to avoid penalties and mistakes. In addition, our lawyers will be at your side if you make a mistake, and so you can minimize any penalties that you may face.