Distribution vs K1

[yekasi]

Hello,

I have a S Corp and i am the sole owner.  I pay myself a 20k W2 salary.  (I believe it is low - i want to change this in 2025)

My S-corp have a revenue of 250k this year.  The business deductions were about 100k (This includes the 10k salary). That gives me a net of 150k Profit.

After I did my tax in turbotax, i have a K1 of approximately 150k.

My questions,

1) So i paid myself a 10k W2 salary, but this K1 itself has 150k.  So my personal tax return actually have 160k as income.  Suppose the numbers are the same next year, so why should I increase my W2 salary to 100k and take a K1 of 60k?  Net Net it seems to be the same on my personal return. I am still liable to pay 160k income tax. 

2) Using the same numbers, suppose I add a distribution withdrawal of 100k, with my 10k salary, i will end up having a K1 of 50k.  Is this 100k distribution taxable on my personal income tax return? 

3) How do you determine if you should have a "bigger K1 value w/ Smaller Distribution" , versus a "bigger  Distribution value w/ smaller k1 end of year value"?

thanks

[DavidD66]

Using your scenario of $160,000 profit before you pay yourself or take any distributions: If you pay yourself $10,000 and take a distribution of $100,000 you will still have K-1 income of $150,000.  Distributions are not deductible like a salary reported on a W-2.  They are a distribution of earnings that either have been or will be taxed as ordinary income.  

The way you can benefit from having an S-Corp, as opposed to being a sole proprietor filing on Schedule C, is by avoiding Self-Employment tax.  When you pay yourself a salary, you must deduct 7.65% of your salary to pay Social Security and Medicare taxes.  The business also pays 7.65% for a total of 15.3%.  When you are self-employed, you pay 15.3% self-employment tax, which is the employer and the employee portions of Social Security and Medicare.  If you are an S-Corp, you are required to pay yourself a "reasonable" salary.  You and your business will pay 15.3% payroll taxes on your salary.  You can then take distributions that are not salary and are not subject to Social Security and Medicare tax.  

Of course, being able to pay yourself and avoid paying the 15.3% in payroll taxes creates an incentive to pay yourself a very low salary, and take large distributions.  If you do, and it's ever challenged by the IRS, they can reclassify some or all of your distributions as salary.   See the following IRS information on paying yourself a reasonable salary:

Wage Compensation for S Corporation Officers

[yekasi]

Thanks.

Suppose my profit is 110k because I increased my salary to 50k now.  I take a distribution of 85k, and a K1 of 25k.

This in turns is giving me,

• Salary of 50k + K1 of 25k = 75k Personal Income where as 75k will have a 15.3% employment tax. 
• Distribution of 85k and this  has no employment tax.

Is this right?

And is that 85K distribution consider as a ordinary income onto my personal return if i pay myself a reasonable Salary? 

thanks

[DavidD66]

No.  The only thing subject payroll tax is your salary.  Your business has a profit of $160,000, less your salary of $50,000, so that's a profit of $110,000.   You get a W-2 for $50,000 that goes on your personal tax return.  You also get a K-1 with $110,000 of Ordinary Business Income, whether you take a distribution or not.  If you take a distribution of $85,000 you still have a $110,000 of ordinary business income.  If you take a distribution, it doesn't affect your income or what you pay in taxes.  It affects your shareholder basis and your bank account.   Let's say you pay yourself $50,000 and take a $10,000 distribution.  You do the same thing for three years, and the business never spends the money.  In year four, you lose money and you don't pay yourself a salary.  You have $300,000 in cash earnings that you can take as a distribution.  It's not taxable, you've already paid tax on it.  Another option for earnings you don't take in distributions is for the business to use it.  Let's say after three years instead of a loss, you're still making money and you decide to buy a building.  You can use some or all of the $300,000 to buy a building.  

And finally, the IRS doesn't define reasonable when it comes to a salary, but I would be skeptical of a salary for a single member S-Corp owner of $50,000 and distributions in excess of that.   

[yekasi]

thank you. I understand now.  So the distribution is just "take money out" and has nothing to do with paying tax on it or not. It is just a method to take money out from business bank account. 

the crux of this lies with saving on the tax from the K1. 

thank you