So you’ve set up your S-corp and now are at the point where you need to take money out. What’s the best way to do it? Will I have to pay tax on the money? These are all common questions for new S-Corp owners. We will go over the different payments and discuss the impact they can have on your taxes.
S-Corporations are pass-through entities. This means that the income that the business makes will be passed on to the owners who then include the income on their own tax returns. The investment S-Corp owners have in their company is called “basis” for tax purposes. Some ways in which your basis can go up are when the business makes a profit or when you contribute property to the S-Corp. Your basis can also decrease when the business has a loss or when the S-Corp distributes property to you.
One way to take money out of your S-Corp is through distributions. Distributions are payments that your S-Corp makes to you that are typically tax-free. The exception is when the S-Corp distributes property to you that is more than your basis. In such cases you will pay capital gains tax on the distribution.
Keep track of your basis, especially if you are one of many shareholders in the S-Corporation. Your Enrolled Agent or CPA should provide this number to you each year.
Another way to take money from your S-Corp is through a salary. Your salary has to run through payroll where the S-Corp withholds and pays payroll tax. Social Security and Medicare tax is 15.3% and is split between the employee and the employer. The S-Corp will have to file payroll tax filings with the IRS and State and provide you with Form W-2 as it would for any other employee.
In fact, the IRS requires that you pay yourself a reasonable salary if you work in the business and take distributions. A reasonable salary is a subjective but you should be able to support that amount. How much would you have to pay someone to do your job? What kind of tasks are you doing? How much time are you spending in the business? What is your experience level? These are all factors that should go into determining what is a reasonable salary.
S-Corporations can also reimburse their owners for business expenses that the employee incurs. It is best if the S-Corp pays all business expenses but that is not always possible. There are times when the owner/employee foots the bill. No need to worry about this. However, documentation for the expense should be provided to the S-Corp and then reimburse the employee within a reasonable time.
The S-Corp can also lend money to its shareholders. A formal agreement should be drafted to clearly show the amount to be loaned, interest and payment schedule. Without an agreement in place the loan can be perceived as s distribution and have unexpected tax consequences as previously described.
Regardless of how you decide to take money out of your S-Corp it is important to document the transactions properly so you will avoid any unforeseen headaches down the road.