S Corporation Distributions: When Taking Money Out Is Taxable
Taking money out of an S corporation does not automatically create a second income-tax bill. The result depends on your stock basis, a tax measure of your investment in the company, and the type of payment you receive.
You can also owe tax on business income without receiving a distribution. Understanding those two rules makes the numbers on your personal return easier to follow.
Business income and cash distributions are separate
An S corporation generally passes its income through to its shareholders. Your Schedule K-1 reports your share, which you include on your return whether the company pays that money to you or keeps it in the business. The IRS shareholder instructions explain that reporting.
A distribution is cash or property you receive as an owner. For an S corporation without accumulated earnings and profits from C corporation years, a regular distribution generally reduces your stock basis without additional income tax. Any amount above your available stock basis generally becomes capital gain.
Companies with C corporation history, stock buyouts, and liquidations can have different rules. The example below assumes none of those circumstances applies.
A cash-distribution example
Assume you own the entire company throughout the year. You begin with $20,000 of stock basis. The company earns $40,000 of taxable business profit after wages and other deductible expenses, then distributes $50,000 to you. There are no other basis adjustments or shareholder loans.
| Calculation | Amount |
|---|---|
| Stock basis at the beginning of the year | $20,000 |
| Add your share of taxable business profit | $40,000 |
| Stock basis before the distribution | $60,000 |
| Subtract the cash distribution | ($50,000) |
| Stock basis remaining | $10,000 |
You report the $40,000 of business income. The $50,000 distribution creates no additional taxable income because it fits within your $60,000 stock basis.
If the distribution were $70,000 instead, the extra $10,000 above stock basis would generally be capital gain, and your remaining stock basis would be zero. The stock's holding period determines whether that gain is short-term or long-term.
Basis changes each year
Your stock basis is different from the company's bank balance or retained earnings. It depends on how you acquired your shares and the adjustments that follow, including capital contributions and your share of income, distributions, expenses, and losses.
The usual annual sequence increases basis for income, including tax-exempt income, then reduces it for distributions, certain nondeductible expenses, and losses. Special adjustments and elections can change parts of that calculation. Stock basis cannot go below zero.
Distributions therefore use stock basis before losses do. A company can have a loss for the year while its shareholder has taxable gain from a distribution. The loss does not automatically cancel that gain.
Form 7203 tracks stock and debt basis. Individual shareholders who receive a nondividend distribution are required to file it with their return, even when the distribution is not taxable.
Loans and wages have their own rules
Money you lend directly to the company can create debt basis, which is tracked separately from stock basis. Qualifying debt basis may help you deduct a business loss, but it does not increase the amount of a distribution you can receive tax-free. Losses also face other limits beyond basis.
Repayment of a shareholder loan is a separate transaction. If prior losses reduced your basis in the loan, repayment can be partly or fully taxable. The IRS explains these distinctions in its stock and debt basis guidance.
If you work for the company, reasonable compensation for your services must be handled as wages. Payments labeled as distributions can be reclassified as wages when compensation is inadequate. Having enough stock basis does not replace the payroll rules.
Property and former C corporations need a closer look
Distributing a vehicle, equipment, or real estate can produce taxable income even though no cash changes hands. If the property's market value exceeds the company's tax basis in it, the company generally recognizes gain as though it sold the property. That gain generally passes through to shareholders and affects their stock basis before the distribution calculation.
The distribution is generally measured using market value, with adjustments for certain liabilities. The company generally cannot claim a loss simply by distributing property worth less than its tax basis. IRS Publication 542 explains the corporate property-distribution rules.
If the company previously operated as a C corporation, or acquired C corporation tax attributes in certain transactions, it may have accumulated earnings and profits. Additional ordering rules can make part of a distribution a taxable dividend even when you have stock basis.
Before deciding how much cash to distribute, consider the company's operating needs, your compensation, and the expected year-end basis calculation. Cash available in the bank answers only one part of that decision.