1. Dividend Basics
2. Compensation Measures
3. Retained Earnings
4. Distribution Assessments

An S corp dividend is income dispensed to shareholders based on his or her portion in a business. All corporations begin as C corps, and you would have to request that the IRS reclassify your business into S status. If your business meets IRS guidelines, the organization will turn your C status into S. Such a designation means that your business is still a disregarded entity, but it is not subject to corporate taxation.

Among many business owners, the S classification is the fastest growing entity type due to its significant tax advantages and flexibility. S corps are domestic entities designated as a pass-through business, meaning that all profit and losses flow from the business to shareholders.

With that, S corps come with certain restrictions in the form of:

  • No more than 100 shareholders
  • All shareholders must be U.S. citizens
  • Other entities cannot own an S corp

However, the advantages outweigh the disadvantages, and the shareholders are entitled to corporate profit shares. When it comes to profit distribution, such matters depend on the way a business pays its taxes. Special tax classification for S corps mandate an allocation process to shareholders annually, but corporations are not obligated to dispense the profits. Any decision regarding the profit distribution, or the holding of money to retain working capital, is based on the laws of your state.

Dividend Basics

When a C corp assesses net income and pays business taxes on that amount, the remainder is designated as profit and placed in a corporate retained earnings account. Dividends are then allocated to shareholders from the retained earnings and taxed once more on an individual shareholder’s return. The double taxation of corporate profit distributions is prevented by the S corp because it is not taxed at the business level.

Moreover, an S corps does not hold retained earnings in the standard sense and does not allocate dividends because they are paid from post-tax profits, and the S corp itself is not subject to taxation. S corp shareholders may also be classified as employees and would get the same tax benefits as any other employee who is not a shareholder. For instance, owners labeled as employees would get the following benefits:

  • Paycheck issuance
  • Withheld taxes
  • Paid employment taxes
  • W-2 form

Compensation Measures

In addition, shareholders working for the S corp should get a reasonable amount of compensation for the work being conducted. Shareholders may also borrow money from the business with a promissory note, and it should include lending terms like the following:

  • Market interest rate
  • Promise to pay
  • Dates regarding repayment

If you spend your own funds on business-related matters, and intend to get reimbursed via the cooperation, make sure to submit documentation to support an S corp’s allocation to you.

Retained Earnings

When a C corp distributes earnings from retained earnings, it is labeled a dividend. C corp shareholders (including the IRS) get Form 1099-DIV, which is handed out by the C corp to report dividends. C corp shareholders then note the dividends on their personal tax returns. According to Section 1368, property or cash distribution via an S corp may add to three possible tax punishments to recipient shareholders:

  • Could result in tax-free reductions on a shareholder’s basis within an S corp’s stock
  • Taxable dividends
  • Gains for the selling of stock (ending in capital gains)

Such options are not mutually exclusive, and you could face the multiple consequences at once. To understand the basic concepts of S corp distributions, you should conduct all research ahead of time. You should be aware of the following attributes:

  • Shareholder attribute
  • Shareholder stock basis
  • Corporate attributes
  • Profits and earnings
  • Adjustments accumulated account

A failure to fully understand the roles that each attribute plays in assessing the taxability of distributions could add unnecessary hardships to the process and may lead to mistakes.

Distribution Assessments

As a shareholder, you pay taxes on your share of the S corporation's profits. For example, if you and a friend own an S corp in an equal manner, and the S corporation makes $250,000, both of you would pay income taxes on your $125,000 shares of the S corporation's profits.

Distributions by S corps to shareholders are not taxable to shareholders. For an S corp shareholder that receives $100,000 in distributions, you would not be taxed on that $100,000.

To learn more about an S corp dividend, submit your legal inquiry to our UpCounsel marketplace. UpCounsel’s attorneys have graduated from some of the best law schools in the nation and will help you through the dividend process, and how you should pay your taxes. Further, they will assist you through any IRS difficulties so you can focus on expanding your business operations.