S Corporations (S Corps) provide a tax advantage by passing income directly to shareholders, avoiding double taxation. However, understanding how distributions work and how they’re taxed is essential for business owners looking to maximize tax efficiency while staying compliant with IRS rules.
S Corp Profits vs. Distributions
A common misconception is that S Corp distributions are taxable income. In reality, distributions themselves are not taxed as long as they do not exceed a shareholder’s stock basis. However, shareholders must pay taxes on their share of the company’s profits, whether or not they take distributions.
An Example of Pass-Through Taxation Works
If an S Corp earns $100,000 and a shareholder owns 50%, they are taxed on $50,000 of income, regardless of whether they receive a distribution.
This is because S Corps are pass-through entities, meaning the company’s income passes through to the owners, who report it on their personal tax returns.
This structure avoids corporate-level taxation, but it can also create cash flow challenges if shareholders are taxed on income they do not actually receive.
Are Distributions Taxable?
S Corp distributions are not taxed as long as they do not exceed a shareholder’s stock basis. If distributions exceed basis, the excess is taxed as a capital gain.
The IRS and Reasonable Compensation
S Corp owners who work in the business must pay themselves a reasonable salary before taking distributions.
- Wages are subject to payroll taxes (Social Security and Medicare).
- Distributions are not subject to payroll taxes.
To prevent business owners from paying themselves low wages while taking large distributions to avoid payroll taxes, the IRS requires S Corp owners to pay a “reasonable salary” for their role.
What Happens If You Don’t Pay a Salary?
If an owner takes distributions without a reasonable salary, the IRS can reclassify those distributions as wages, resulting in:
- Back taxes
- Penalties
- Interest
Ensuring proper salary structuring is essential, and JBS Corp can help S Corp owners determine a fair and compliant compensation plan.
What Happens If Distributions Exceed Basis?
A shareholder’s basis in an S Corp is the amount they have invested in the company, including:
- Initial capital contributions
- Additional investments
- Their share of company income
- Reduced by losses and distributions
Tax Consequences of Exceeding Basis
If an owner takes distributions that exceed their stock basis, the excess amount is taxed as a capital gain. This can create an unexpected tax bill, making it essential to track basis carefully.
Looking for S Corp Tax Help?
Proper tax planning for an S Corp requires balancing wages and distributions, tracking shareholder basis, and ensuring compliance with IRS rules.
S Corp Tax Planning Services
JBS Corp specializes in helping S Corp owners with tax strategy, ensuring they:
- Pay a reasonable salary to reduce likelihood of IRS audits
- Structure distributions properly to reduce tax liability
- Track basis correctly to avoid unexpected capital gains taxes
- Stay compliant with IRS rules and regulations
Whether you need guidance on reasonable salary calculations, distribution planning, or tax compliance, JBS Corp can provide the expertise to keep your business financially efficient and IRS-ready.
Final Thoughts
S Corp distributions can be a tax-efficient way to take profits from a business, but they must be handled correctly to avoid IRS penalties and unexpected tax liabilities.
Ensuring proper salary structure, tracking basis, and working with a tax professional can help maximize tax savings while maintaining compliance.
For expert S Corp tax planning and compliance support, contact JBS Corp today.
