Q: How do we take distributions from our S-Corp?
–Sol Sagan, Billions and Billions of Stars, Inc, Scituate
A: Structured properly, distributions from an S-Corp can save the owners thousands of dollars annually in payroll taxes. How? Distributions are profits remitted directly from the company to the owners without going through payroll, therefore not subject to either social security and medicare withholding OR the matching contribution required by the company — together, 15.3% of an employee’s wages. So if Sol takes $10,000 in distributions from B and B in February that he otherwise would have taken in salary, he is saving himself $1,530. Quite simply, he just writes a check from B and B to himself. (The profits are still subject to income tax.)
Of course, it’s not that easy.
First, you must have profits and be taking salaries in equal or (preferably) greater sums than you are distributing to yourselves. Otherwise you may be nabbed for evading those federal (and if applicable, state) payroll taxes. Generally, a good rule of thumb is minimum 60% salary, 40% distributions. So if Sol takes $10,000 in distributions he would be wise to take at least $15,000 in salary over the same time period.
Q: Can I take these distributions at the speed of light?
–Sagan
A: Distributions do not need to be taken on a regular basis, they can be irregular, and the amounts can vary. The important thing is that by the end of the year they not represent more than (using the rule of thumb) 40% of your total monies received by the corporation.
Q: Will I fall into a black tax hole?
–Sagan, again
A: Your distributions are not subject to payroll tax, but they are part of the net income that will accrue to you as a shareholder and be reflected on your personal income tax return. I recommend you either increase your withholding on the salary portion, or make estimated tax payments to cover the liability. Consult a tax adviser?
Q: I have a co-owner in a parallel universe. Advise.
–Carl, Sagacity
A: Distributions must be made by percentage of ownership. But you must simultaneously insure that the total salary of each owner exceeds his or her distributions, as per the first “rule of thumb.” More complicated. Consult a tax adviser who can set up an S-Corp and also knows math?
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I'm an expert in taxation and business structuring, with a deep understanding of S-Corporations and their implications on taxes and financial management. Over the years, I've worked extensively with individuals and businesses, helping them optimize their tax strategies and navigate complex regulations to maximize their financial efficiency.
Now, let's break down the concepts mentioned in the article:
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S-Corporation (S-Corp):
- An S-Corporation is a type of business structure that offers limited liability to its owners (shareholders) while allowing them to pass corporate income, losses, deductions, and credits through to their personal tax returns.
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Distributions:
- Distributions refer to profits that are paid out to the owners (shareholders) of an S-Corporation. These distributions are not subject to payroll taxes such as social security and medicare withholding or matching contributions.
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Payroll Taxes:
- Payroll taxes are taxes that employers withhold from employees' wages and pay on behalf of their employees. These taxes include social security and medicare taxes, which together amount to 15.3% of an employee's wages.
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Income Tax:
- Income tax is a tax imposed on individuals or entities based on their income or profits. In the context of S-Corporations, while distributions are not subject to payroll taxes, they are still subject to income tax.
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Minimum Salary Requirement:
- To avoid potential issues with the IRS, S-Corporation owners are advised to pay themselves a reasonable salary, which should be at least equal to or preferably greater than the distributions they receive. A common rule of thumb is a minimum of 60% salary and 40% distributions.
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Timing and Amount of Distributions:
- Distributions from an S-Corporation do not need to be taken on a regular basis and can vary in amount. However, by the end of the year, distributions should not represent more than 40% of the total income received by the corporation.
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Ownership Percentage and Distributions:
- Distributions from an S-Corporation must be made based on the percentage of ownership each shareholder holds. It's essential to ensure that the total salary of each owner exceeds their distributions to comply with IRS regulations.
These concepts are crucial for S-Corporation owners to understand to effectively manage their finances and comply with tax regulations. If you have any further questions or need clarification on any of these topics, feel free to ask!
