S Corp Distributions Tax Rate: Everything You Need to Know
An S corp distributions tax rate depends on your business income.3 min read
2. Possible Consequences
3. S Corp Basics
4. Section Goals
5. Basis Breakdown
6. Earnings and Profits
An S corp distributions tax rate depends on your business income. S corp shareholders who work for the business as employees may be classified as employees to get the same tax treatments as employees who are not shareholders. Shareholders/employees can get the following benefits:
- Withheld taxes
- Employment taxes paid
Further, shareholders who work as employees must be paid a reasonable salary for the work being conducted.
In addition, shareholders can borrow from the business, but they should use a promissory note to do so. The note should include the following:
- Interest rates
- Promise to repay
- Date of repayment
If you spend your personal money on business matters and wish to get reimbursed by the S corp, you must include documentation showing the S corp’s reimbursement to you.
C Corp Basics
When a C corp dispenses earnings from retained earnings, it is known as a dividend. C corp shareholders get Form 1099-DIV, a form that a company issues to shareholders so they can record dividends. C corp shareholders report the dividends on their personal tax returns.
According to Section 1368, the distribution of property or money by an S corp creates three possible consequences to the shareholder:
- Distribution could result in tax-free reductions of the shareholder’s basis in corporate stock
- Taxable dividends
- Gains from the selling of stock (ending in capital gains)
It’s worth noting that all consequences are not mutually exclusive, and you could face multiple penalties at once.
S Corp Basics
To fully understand the basic concepts of S corp distribution, you must be familiar with certain terms to determine the taxability of S corp distributions:
- Shareholder attribute
- Shareholder stock basis
- Two corporate attributes
- Profits and earnings
- Adjustment accumulated account
The main goal of Section 1368 is to preserve differences between C and S corps, especially in regards to profits and earnings. For instance, a C corp must be taxed two times, one at the business level and another when shareholders file their personal tax returns. S corps are not taxed at the business level, and shareholders would only pay taxes upon filing their returns.
According to Section 1367, shareholders within an S corp must make annual adjustments to his or her basis in corporate stock to accurately reflect items pertaining to the following:
- Income gains
- Distributions to shareholder
Such adjustments are vital in preserving single-level taxation within S corps. The shareholder should enhance the basis of his or her S corp stock regarding:
- Capital contributions
- Income items (including tax-exempt sources of income)
Further, shareholders should lower basis on distributions in the following cases:
- Other those distributions taxed as dividends under Section 1368
- Deduction and loss items (including nondeductible expenses that cannot be chargeable to capital accounts)
In addition, you must be aware of the adjustment sequence. Although distributions lower basis, in many instances, the shareholder’s stock basis will assess a distribution’s taxability.
Various regulations mandate that a stock basis first be adjusted for necessary enhancements to basis. Also, stock basis is lowered via distributions before reductions in nondeductible expenses or losses. With that, a basis may not be lowered below zero in regards to the extent in which losses surpass the remaining stock basis after reductions in nondeductible expenses and distributions. This also applies to excessive losses applied to lower a basis the shareholder has in how much an S corp owes to shareholders.
If losses surpass a shareholder’s basis in debt and stock, such losses are then suspended and can be carried over on an indefinite basis.
Earnings and Profits
When it comes to earnings and profits, you may run into two scenarios:
- The business had amassed E&P when the S corp was a C corp in previous years
- The S corp obtained virtually all the assets of a C corp in a transaction that qualifies under Section 381, mandating that the S corp succeed to the E&P of the targets.
To learn more about an S corp distributions tax rate, submit your legal inquiry to our UpCounsel marketplace. UpCounsel’s attorneys assist with tax law and the best way to maximize your deductions so you can get the right amount that your S corp owes you. Further, they will be at your side if you have questions regarding tax deductions, or if you have general questions on how to manage your S corp.