Shareholder Distribution vs. Payroll (2024)

FAQs

Is it better to take a salary or distribution? ›

So any income you take as distributions rather than salary saves you that cost in taxes. To curb the obvious temptation to take all your gross receipts as distributions rather than salary, the IRS sets a basic guideline: You have to pay yourself a “reasonable salary.”

S corporations typically pay payroll taxes – Medicare and Social Security taxes – on any salaries paid to employees. Shareholders distributions don't incur payroll taxes, but they are subject to income tax.

For tax purposes, distributions are part of your ordinary income.

A shareholder distribution is a way to take funds out of your business without incurring payroll taxes.

When the income is distributed to its shareholders, it is generally taxed as a dividend. This results in the same income earned by the corporation being taxed twice (double taxation), once at the entity level and again at the shareholder level.

You may or may not have heard of the S Corp Salary 60/40 rule. The guideline refers to setting reasonable compensation between 60% and 40% of the business's net profits. This guideline is not set by the IRS. It should not be relied on as the only factor when setting reasonable compensation.

S Corporations are unique in that they offer both the limited liability benefits of a corporation and the pass-through taxation of a partnership. In an S Corp, paying yourself generally involves a combination of a salary as an employee and distributions as a shareholder.

How dividends are taxed depends on your income, filing status and whether the dividend is qualified or nonqualified. Qualified dividends are taxed at 0%, 15% or 20% depending on taxable income and filing status. Nonqualified dividends are taxed as income at rates up to 37%.

Under a 60-40 approach, the split between salaries and distributions should be 60% for salaries and 40% for distributions. For example, assume that Ted is the sole SE in his profitable S corporation, working full time as its CEO.

Profit split evenly (50/50) between salary and profit distribution is one way to avoid leaving any money on the table. For example, if an S Corp owner earns $50,000 annually, they'd pay themselves a $25,000 salary and $25,000 profit distribution.

How do I pay taxes on S corp distributions? ›

Profit or loss from the corporation is included in the shareholder's basis, and any distributions would decrease the shareholder's basis. The shareholder would be taxed on distributions that exceed the amount of their basis as a capital gain on Schedule D (Form 1040) Capital Gains and Losses.

The instructions to the Form 1120S, U.S. Income Tax Return for an S Corporation, state "Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation."

A distribution is a company's payment of cash, stock, or physical product to its shareholders. Distributions are allocations of capital and income throughout the calendar year. When a corporation earns profits, it can choose to reinvest funds in the business and pay portions of profits to its shareholders.

A distribution is a payment of earnings to shareholders, usually in the form of cash or stock, and is taxed at the shareholder level. Unlike a salary, distributions aren't subject to payroll taxes, employment taxes, Social Security, or Medicare taxes.

Dividend distributions paid to shareholders of an S corporation are reported on Form 1099-DIV Dividends and Distributions , and on Schedule K, Line 17c. Loan repayments to shareholders are reported on Schedule K, Line 16e, and on each individual shareholder's Schedule K-1, line 16, with "E" as the reference code.

The downsides of salary pay

This can result in longer work hours without additional pay. Salaried positions often have more rigid schedules and sometimes less flexibility than hourly jobs if they're required to work the typical 9-5 schedule. This can make it challenging to balance work and personal commitments.

How dividends are taxed depends on your income, filing status and whether the dividend is qualified or nonqualified. Qualified dividends are taxed at 0%, 15% or 20% depending on taxable income and filing status. Nonqualified dividends are taxed as income at rates up to 37%.

If taking a pay cut works out from a personal finances perspective, as well as a career development perspective, then you should consider going for it. Just make sure that taking a pay cut for less stress won't accidentally translate into more stress, both in the short term and over the course of a couple years.