S Corporation Owners
Taking money out of your S corporation does not necessarily mean you have additional taxable income. For many S corporation owners, business income, shareholder distributions, and taxable income are three different concepts.
How a distribution affects your individual income tax return depends on factors including the corporation's tax history and your shareholder stock basis.
Are S Corporation Distributions Taxable?
Many S corporation distributions are not separately taxable when the shareholder has sufficient stock basis. Instead, the distribution generally reduces the shareholder's stock basis.
If a nondividend distribution exceeds the shareholder's available stock basis, however, the excess may result in taxable capital gain. Different rules can apply when an S corporation has accumulated earnings and profits from prior C corporation years.
K-1 Income, W-2 Wages and Distributions Are Different
S corporation owners sometimes use these terms interchangeably, but they represent different parts of the tax picture.
W-2 Wages
Compensation paid to a shareholder-employee for services performed for the corporation. Wages are generally subject to applicable payroll taxes and income tax withholding.
K-1 Income
Your share of the S corporation's income, deductions, credits and other tax items. You can owe tax on S corporation income even when the corporation does not distribute that income to you in cash.
Shareholder Distributions
Cash or property transferred from the corporation to a shareholder. A distribution is not automatically additional taxable income merely because the shareholder received cash.
A Simple Example
Assume an S corporation reports $100,000 of income allocable to its sole shareholder but distributes only $60,000 in cash during the year.
The shareholder generally does not simply report the $60,000 received as taxable business income. The shareholder may instead be required to report the $100,000 of pass-through income from the Schedule K-1, whether or not all of that income was distributed.
The $60,000 distribution is a separate transaction. Its tax treatment depends in part on the shareholder's stock basis and other applicable S corporation distribution rules.
Why Shareholder Stock Basis Matters
Stock basis is an important part of an S corporation shareholder's individual tax records. It changes over time as the corporation earns income, incurs losses, makes distributions, and experiences other transactions affecting the shareholder.
In general, income items increase stock basis, while distributions, losses, deductions, and certain other items can reduce it.
Because distributions can become taxable when they exceed available stock basis, accurate basis information can be essential when preparing an S corporation owner's personal tax return.
Basis Can Affect More Than Distributions
Shareholder basis can become important in several different situations on an individual tax return.
Stock basis helps determine whether a nondividend distribution is taxable.
Basis limitations can restrict the amount of S corporation loss currently deductible on the shareholder's return.
Stock basis is relevant when determining gain or loss if the shareholder later disposes of the stock.
Loans made directly by a shareholder to the corporation can involve separate debt-basis considerations.
What Is Form 7203?
Form 7203, S Corporation Shareholder Stock and Debt Basis Limitations, is used to calculate and report certain shareholder stock and debt basis information.
Depending on the circumstances, an S corporation shareholder may be required to file Form 7203 with the individual tax return, including situations involving nondividend distributions, S corporation losses, stock dispositions, or certain shareholder loan repayments.
Common S Corporation Distribution Issues
No Basis Records
The K-1 provides information used in the basis calculation, but the shareholder is responsible for maintaining the information necessary to determine stock and debt basis.
Distribution Exceeds Basis
A nondividend distribution exceeding available stock basis can result in taxable capital gain.
Confusing Income With Cash
The amount of taxable K-1 income for the year may be very different from the amount actually distributed to the shareholder.
Prior-Year Basis Problems
Missing prior-year information can make the current-year basis calculation more difficult, particularly after years of income, losses and distributions.
Shareholder Loans
Stock basis and debt basis are separate concepts. Debt basis generally does not make an otherwise excess distribution tax-free.
Former C Corporation
Additional distribution rules can apply when the S corporation has accumulated earnings and profits from prior C corporation years.
What We Need for Your Personal Tax Return
Your final Schedule K-1 provides important information about income, deductions and distributions from the S corporation. Depending on your situation, we may also need information supporting your shareholder basis and prior-year basis activity.
If prior-year returns or basis schedules are available, providing them can help establish continuity between prior-year and current-year shareholder reporting.
TaxReturn.cpa Prepares the Individual Return
TaxReturn.cpa is focused on individual income tax preparation. Preparation of the corporation's Form 1120-S is a separate business tax service available through Boulanger CPA and Consulting PC.
If the S corporation return has already been completed, we can use the final Schedule K-1 and other applicable shareholder information when preparing your individual return.
Related S Corporation Tax Resources
Frequently Asked Questions
Do I pay income tax when I take a distribution from my S corporation?
Not necessarily. Many nondividend S corporation distributions are nontaxable to the extent of available shareholder stock basis. A distribution exceeding stock basis may result in taxable gain.
Is my S corporation distribution the same as my K-1 income?
No. Schedule K-1 reports your share of the corporation's tax items. A distribution reflects cash or property transferred to you. The amounts can be very different.
Can I owe tax even if my S corporation did not distribute cash to me?
Yes. S corporation shareholders generally report their share of the corporation's taxable income whether or not that income was distributed to them.
Does a shareholder loan increase the amount I can distribute tax-free?
Generally, debt basis and stock basis are separate. When determining whether a nondividend distribution exceeds basis, stock basis is the relevant basis calculation rather than shareholder debt basis.
Who is responsible for tracking my S corporation basis?
The shareholder is responsible for maintaining the information necessary to determine stock and debt basis. Schedule K-1 provides information used in the calculation, but the K-1 itself does not state the taxable amount of a shareholder distribution.
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