Tax consequences of “Excess Distributions” for S Corporation shareholders
The “S “ election for corporations has some definite tax advantages. The election allows shareholders to report the corporate income and deductions on their personal returns. These items are taxed at the individual’s income tax rates, which are typically lower than corporate tax rates, and avoids double taxation on the corporate income.
In addition, non-dividend distributions can be taken free of dividends tax as well as self-employment tax (Which is a social security and Medicare tax primarily for individuals who work for themselves). This is not to say that all payments to shareholders can be treated as distributions.
The IRS very specifically states that S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. In other words, shareholders of S Corporations must take W-2 wages with proper withholding for social security and Medicare taxes prior to taking distributions. The IRS does have the authority to reclassify distributions as wages, which are subject to employment taxes. We recommend basing the shareholder’s compensation on industry compensation guides or RMA annual statement studies data specific to the company’s industry.
S Corporation shareholders must also be aware of the consequences of taking distributions in excess of stock and debt basis. Stock basis begins with the initial capital contribution to the S Corporation or the initial cost of the stock purchased. Stock basis is increased with profits and decreased with losses. Distributions taken in excess of the stock basis are taxed as capital gains (generally long-term) on the shareholders personal return. The current long-term capital gains rate is 15%. It is very important to consider whether or not there is basis available when taking distributions. In addition, losses of the corporation can only be deducted if there is sufficient basis to cover the loss.
Shareholder loans are considered debt basis. Debt basis is only allowed to the extent that the shareholder has personally contributed funds to the corporation. Losses in excess of stock basis can be deducted to the extent that the shareholder has made personal loans to the corporation. However, if losses are applied against the shareholder loan amount, the debt basis is reduced and any repayment to the shareholder of the loan will result in a tax consequence. If you have a question about this topic, please contact us at 630.584.4555
FAQs
Review Form 8949, Part II. Box F is checked and the description shows as "Excess Distribution" with the name and EIN of the S corporation listed: Note: Distributions in excess of stock basis are treated as capital gains regardless of whether or not the taxpayer has debt basis.
What does excess distribution mean? ›
An excess qualifying distribution is the amount by which the total qualifying distributions treated as made out of undistributed income for any tax year beginning after 1969, or as made out of corpus for the tax year (other than distributions by donee organizations described in Certain contributions to exempt ...
How do you calculate gain on excess distributions? ›
UltraTax CS calculates the gain on excess non-dividend distributions by taking the difference between the shareholder's stock basis before any current-year reductions for total losses and deductions, and the current-year non-dividend distribution for the shareholder.
What happens when distributions exceed basis? ›
A non-dividend distribution in excess of stock basis is taxed as a capital gain on the shareholder's personal return.
Do I need to report distributions? ›
File Form 1099-R for each person for whom you have made: a distribution of $10 or more from profit-sharing or retirement plans, IRAs, annuities, pensions, insurance contracts, survivor income benefit plans, etc.
How do I correct an excess 401 K contribution? ›
Here are some steps to take:
- Contact Your Employer or Plan Administrator Immediately. Let your employer know that you've overcontributed. ...
- Correct Your Tax Forms. If you can catch the problem before tax day and before you file your taxes, you can get a corrected W-2 to use. ...
- Pay Taxes on the Excess Contribution.
In mathematics, specifically in the theory of generalized functions, the limit of a sequence of distributions is the distribution that sequence approaches. The distance, suitably quantified, to the limiting distribution can be made arbitrarily small by selecting a distribution sufficiently far along the sequence.
How can I avoid PFIC status? ›
Shareholders with a 10 percent or more interest in a CFC in which other U.S. shareholders own and control the stock are not subject to the PFIC rules. A startup can avoid the PFIC designation if all U.S. shareholders own their interest through a corporation that holds a 10 percent or more interest in the CFC.
What are excess distributions in a private foundation? ›
If a foundation makes qualifying distributions that exceed the current year's distributable amount and the previous tax year's undistributed income, it has created “excess qualifying distributions.”3 The foundation may use such excess distributions to reduce the distributable amount in any of the five tax years ...
How do I report distributions in excess of basis on 8949? ›
Use Form 8949 to include the income from the excess distribution income on your return. To report short-term amounts, use Part I and check box “C” Short-term transactions not reported to you on Form 1099-B. On line 1, column (a), Description of property, enter the name of the company followed by “excess distribution”.
If your Roth contributions exceed your household limits for whatever reason, you have until the following year's tax deadline to make a correction. For example, say that you exceed your Roth limits in 2024. You can fix this error by April 15, 2025, or October 15, 2025 if you file for an extended deadline.
What happens to your Roth IRA if you make too much money? ›
The money remains invested and is yours to keep. Is there a penalty for contributing to a Roth IRA above the income limits? Excess contributions are subject to a 6% excise tax for each year they remain in your Roth IRA. To avoid this penalty, withdraw the excess funds before your tax deadline.
What is distributions in excess of accumulated earnings and profits? ›
Distributions in excess of accumulated E&P are considered a return of capital, to the extent of basis in the stock of the distributee. Distributions in excess of basis are considered capital gains pursuant to IRC §301(c).
How do distributions affect taxes? ›
Dividends come exclusively from your business's profits and count as taxable income for you and other owners. General corporations, unlike S-Corps and LLCs, pay corporate tax on their profits. Distributions that are paid out after that are considered “after-tax” and are taxable to the owners that receive them.
What is excess basis on taxes? ›
Let's talk about distributions in excess of basis. You cannot take more money out of the company than you put in. Your basis is what income gains and losses have been allocated to you based on your ownership percentage. Plus, any contributions that are made to the business are included.
Is excess distribution taxable? ›
Stock basis is increased with profits and decreased with losses. Distributions taken in excess of the stock basis are taxed as capital gains (generally long-term) on the shareholders personal return.
How do I report 1099 R with excess contributions? ›
Excess contributions must be included as income for the year in which the contributions were made. If the excess contributions haven't already been claimed in that year, the return will need to be amended to include the excess distribution as income.
How are distributions reported to the IRS? ›
Form 1099-DIV is used by banks and other financial institutions to report dividends and other distributions to taxpayers and to the IRS.
How do I report a distribution on my tax return? ›
Report your early distribution on your U.S. Individual Income Tax Return (IRS Form 1040) and attach Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts (IRS Form 5329) .
