S Corp Dividend Tax Rate: Everything You Need to Know
An S corp dividend tax rate depends on variety of factors, most notably your business income.3 min read
2. Income Breakdown
3. Tax Possibilities
4. Key Attributes
An S corp dividend tax rate depends on variety of factors, most notably your business income. An S corp begins as a standard C corp, but you can turn it into an S corp if you make a special request to the IRS. If you meet certain parameters, you may get a special S classification from the IRS.
This means that you’ll be taxed on an individual level, and your business would not be taxed, thus avoiding double taxation. In essence, all losses and profits flow from the business to shareholders so they can file such information on their personal tax returns.
S corps are the fastest-growing entity types because they are popular choices among small business owners. However, you must adhere to certain guidelines:
- S corps may not have over 100 shareholders
- Non-U.S. citizens and residents cannot own shares in an S corp
- Other entities cannot an S corp
Overall, all shareholders within a corporation must get a share of corporate profits. The manner in which profits get distributed depends on how a corporation pays its taxes. An S corp’s tax status mandates profit corporations-are-taxed-as-a-pass-through-entity" target="_blank">allocation to shareholders annually, but corporations are not required to distribute profits. The distribution of profits, or the retention of them, depends on state law.
C Corp Essentials
In essence, C corps pay dividends from post-tax profits. Once the C corp determines net business income and pays taxes, the remaining amount is then placed in a retained earnings account. From there, the business distributes the remaining profits to shareholders from retained earnings, and the shareholders are taxed once they file their individual tax returns. An S corp does not have retained earnings in a standard sense and does not issue dividends because the dividends are paid post-tax profits, and S corps are not subject to taxation.
If an S corp allocates $125,000 profit to you (the shareholder), the character of such income is important. If income is standard income, you would pay the standard income tax rates. If the income is considered capital gains, or dividends, you would pay a lower tax rate (ranging from 0 percent to 20 percent).
Another tax you should be aware of is the 3.8 percent net investment income tax, otherwise known as the Obamacare tax. Such a tax does not affect standard income that comes out of an S corp if a shareholder is involved in the business.
Under Section 1368, a cash distribution or property via an S corp may give way to three tax ramifications to shareholders:
- Distributions could result in reductions that are tax-free to the basis of a shareholder within the corporate stock
- Dividends that are taxable
- Gains from the selling of stock (ending in capital gains)
The aforementioned consequences are not mutually exclusive, and you may end up dealing with multiple consequences at once.
To understand the basic concepts of S corp distributions, you must know that determining a distribution’s taxability is paramount. Also, you need to be aware of the following attributes:
- Shareholder Attribute
- Stock Basis
- Corporate Attributes
- Earnings and Profits
- Adjustments Accumulated Account
Failure to understand such attributes could result in needless hurdles and wrong answers.
S corps that issue distributions to shareholders are not taxed. For instance, a shareholder that receives a $100,000 distribution check from an S corp means the $100,000 received is not taxed.
- Note: One of the most important things to remember is the order in which adjustments are made. This is due to the fact that distributions decrease the basis in many instances, but it is a shareholder’s stock basis that determines distribution taxation.
According to Section 1367, the shareholder of an S corp must adjust his or her corporate stock on an annual basis to show accurate items in the form of:
- Income Gain
Such adjustments are vital in preserving single-level taxation in S corps.
In addition, shareholders must increase S corp stock basis on the following items:
- Capital contributions
- Separated stated income items (including income that’s tax exempt) and non-separate computed income
- Excesses in deductions in the depletion over property basis that’s open to depletion
To learn more about an S corp dividend tax rate, 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 in areas pertaining to dividends and tax rates that are applicable to your business. In addition, they will guide you through adjustments and deductions so you can avoid making unnecessary mistakes.