How Can an S Corporation Shareholder Take Cash Out Of Their Business? | USTaxAid

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How Can an S Corporation Shareholder Take Cash Out Of Their Business?

Written by Diane Kennedy, CPA on June 19, 2022

Some of the most recent IRS audits have been focused on S Corporations and their shareholders. A big question is “How does the shareholder take money from the company?”

Let’s start with an officer of the company. If the officer performs no services and receives no pay, they are not considered to be an employee.

The income (or loss) from the S Corporation is reported on the S Corp’s return and Schedule K-1. The Schedule K-1 reports the income or loss and specific income and deductions such as interest, rent received and Section 179 deduction that might have been taken by the business. Other than these few exceptions, the net income or loss of the S Corp are reported as a lump sum on a K-1 which then is reported on the shareholder’s tax return.

Unlike a C Corporation, S Corporation dividend distributions aren’t taxable to the shareholder. The income is taxable to the owners , whether it’s in the form of  profit from the business or the salary paid to an employee owner.

Is a Shareholder Paid As an Employee (W-2) or Independent (1099)?

You can’t designate a worker, including yourself, as an employee (W-2) or independent contractor (1099) simply by issuing a form. A Form 1099 is used to report payments to someone who is not an employee. A Form W-2 reports wages to an employee.

The business is liable for payroll taxes and withheld income tax for employees. If the business doesn’t pay your workers as employees, and they should have been, the business can get hit with taxes and penalties.

This is a hot issue right now. The IRS and states don’t want employers to pay employees like contractors when they really aren’t. And, in the case of shareholders, the IRS is especially watching to make sure S Corporation shareholders who work in the S Corporation as employees receive reasonable compensation. You, as a shareholder, can’t simply take money out of the business and call it a nontaxable distribution. You must be paid reasonable wages for the work you do.

Is Your S Corp a Big Fat IRS Red Flag?

Can S Corp Income Be Considered Passive Income?

Be Careful of Shareholder Loans From Your S Corporation

If you’re not careful, the IRS will call a shareholder loan from your S Corporation compensation instead of a loan. To make sure your loan STAYS a loan and isn’t taxable income, include the characteristics of the loan (interest rate, term, collateral) in a written document and show that all terms are arm’s length. In other words, you would make the same kind of loan to a stranger. If the interest rate is too far below market rate, the difference could be considered a payment of wages, a gift or other form of payment.

With just a little planning and paperwork back-up, you can ensure that you avoid excess taxes from your S Corporation income. We discuss business and real estate tax strategies on the 1st – 4th Wednesday of the month at 5 pm Pacific. Come join us as part of Wednesday Coaching.

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