I own 100% of my S-corp. What is the difference between taking an owners draw and paying a shareholder?

[mrdougtime]

Turbo tax asks me to enter an amount for cash I took from the business and later asks me if I paid shareholders owning more than 2%. Is this a redundancy if I am the only shareholder? What is the difference between taking an owners draw and paying shareholders?

[bobz11540]

If I pay myself a salary where do I generate the W-2?

[Howard1948 · Accepted solution]

Paying yourself wages as an employee of the S corporation results in Federal income tax, Medicare and Social Security being withheld from your pay and remitted at least quarterly to the Treasury.  It also means the employer S corporation pays matching amounts of Medicare and Social Security as a business expense to the Treasury.  It also may mean other applicable taxes such as unemployment benefit taxes, SUI, FUI and who knows how many other Federal and state taxes there are on employee wages.

On the other hand, a distribution of income of the S corporation to a shareholder is a tax-free payment.  Since the shareholder picks up his/her share of the income of the corporation whether it is distributed or not, a distribution itself is not a taxable event.  And no payroll taxes are withheld.  And the distribution is not subject to the Self-Employment Tax.

Now, don't get the idea that you can forego any wages in favor of all distributions.  The IRS figured that out also and volumes of material have been written on how they might re-characterize a distribution as wages to collect the payroll taxes.  Your best bet is to make a stab and the division yourself so you show that you recognize that a wage payment to a controlling shareholder is part of the game.  As long as you're reasonable in the split (and don't get me started on what reasonable means) the IRS will most likely leave you alone.  But if you say everything is a distribution and there are no wages, be prepared to fight a losing battle if and when they come knocking.

Incidentally, after year end, you cannot go back and re-characterize a distribution as wages since you did not report those wages on a quarterly payroll return nor did you give yourself a W-2.  So you may be "up the creek" for 2015 but forewarned for 2016.

[CPY1]

If the S-Corp owner just runs payroll and pays taxes, but doesn't actually take the salary amount from the the Corporation,

#1)  What is the P&L impact?  If they take the money, it will be salary expense hence cut taxes.

If they don't take the money out (I think they are hurting themselves) by inflating profits artificially and paying more taxes later.

What is the Balance Sheet Impact?

Is it a) sits in salaries payable b) move to owner's contribution c) If they are also taking draws, will you net against it.

thanks

[Critter]

If you do not move the funds out of the corporate account then it has no effect on the P&L ... on the books it will be an expense of  wages and a balancing entry as a loan from shareholder.   With an S-corp the earnings are taxed in the year earned and not the year the profits are distributed.   I highly recommend you seek professional assistance in getting your books set up correctly and/or getting educated in the way of keeping the books. 

[Rick19744]

Just as a point of clarification, distributions are not taxable to the extent that a shareholder has basis in the S corp stock.

In addition, there is the possibility that a distribution can be taxable if it exceeds the AAA (accumulated adjustments account) and there is E&P (earnings and profits).  This occurs if the S corp acquired a previous C corp that had earnings and profits or the S corp was a previous C corp and converted to S corp and also had E&P.

If the later is a possibility, you need to get some professional tax advice to understand how this works.

[SCGI]

Your statement "...a distribution of income of the S corporation to a shareholder is a tax-free payment."  Is incorrect.  It is subject to Federal Income Tax.

[jpgroup]

Okay, I have the same situation.  Have an S-Corporation, am it's sole 100% shareholder and pay myself from it as a 1099 contractor.

If I use your plan of some "wages" (as 1099-Misc) and some "dividends" (1099-DIV), say a 50/50 split, what kind of dividends are those designated as?: Ordinary, Qualified, Capital Gains distribs., Non-dividend distribs., Cash Liquidation, etc., what?  (Choices on 1099-DIV form below:)

1a- Ordinary dividends 1b- Qualified dividends 2a- Capital gain distributions   2b- Unrecaptured Section 1250 gain

2c- Section 1202 gain   2d- Collectibles (28%) gain   3- Nondividend distributions   4- Federal income tax withheld   5- Section 199A Dividends   6- Investment expenses   7- Foreign tax paid   8- Foreign country or US possession   9- Cash liquidation distributions   Account number (optional)

I'm a one-man shop, with an occasional contractor (other than me) that I pay with 1099 accounting.

What do each mean?

Which one should I use?

I just want to collect all the income that I received through the corporation each year.

[Critter]

As the owner of an S-corp you CANNOT 1099 yourself ... you MUST pay yourself wages and file all the proper payroll tax returns like the W-2, W-3 & 941/940/944. 

Seek assistance from a payroll company if you do not understand how to do this ... ADP & Paychex are nationwide and reliable.  

[Critter]

If you do not understand how an S-corp works then I highly recommend you seek local professional advice to get educated ... you do not take dividends or non employee compensation as an owner... that is rule #1.

[SCGI]

The IRS generally considers $50,000 to be a reasonable annual salary for S-Corp owners.

[tagteam]

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@SCGI wrote:

The IRS generally considers $50,000 to be a reasonable annual salary for S-Corp owners.

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It really does not appear as if one can make a blanket statement concerning what constitutes a "reasonable annual salary" - it is entirely dependent upon the circumstances and receipts.

See https://www.thetaxadviser.com/issues/2011/aug/nitti-aug2011.html

[jpgroup]

Okay tagteam:

Thank you for your input.

However, please excuse my ignorance of Tax Lexicon babel , but would someone please simply tell me the difference between "salary" and "distributions"?  Is the latter (distributions) reported to IRS in Dividends via 1099-DIV's, and if so (getting back to my earlier box example on the 1099-DIV form, which box do I enter my total lump sum YTD amount in?  There are no "it depends", it's simple pass-through income.

I read your link and fit the following example:

As these employment tax obligations have climbed, the advantage of operating as an S corporation has become magnified. Since S corporation income is not subject to self-employment tax, there is tremendous motivation for shareholder-employees to minimize their salary in favor of distributions, which are not subject to payroll or self-employment tax. Consider the following examples.

Example 1 : A owns 100% of the stock of S Corp., an S corporation. A is also S’s president and only employee. S generates $100,000 of taxable income in 2011, before considering A’s compensation. If A draws a $100,000 salary, S’s taxable income will be reduced to zero. A reports $100,000 of wage income on his individual income tax return, and S and A are liable for the necessary payroll taxes. S is required to pay $7,650 (7.65% of $100,000) as its share of payroll tax, and S withholds $5,650 (5.65% of $100,000) from A’s salary toward A’s payroll obligation, resulting in a total payroll tax bill of $13,300.

Example 2: Alternatively, A withdraws $100,000 from S as a distribution rather than a salary. S’s taxable income will remain at $100,000 and will be passed through to A and reported on his individual income tax return, where it is not subject to self-employment tax. The $100,000 distribution is also not taxable to A, as it represents a return of basis. 7 By choosing to take a $100,000 distribution rather than a $100,000 salary, S and A have saved a combined $13,300 in payroll taxes.

How are the distributions identified to IRS?

[tagteam]

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@jpgroup wrote:

...tell me the difference between "salary" and "distributions"?  Is the latter (distributions) reported to IRS in Dividends via 1099-DIV's, and if so (getting back to my earlier box example on the 1099-DIV form, which box do I enter my total lump sum YTD amount in?  

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Salary is compensation essentially for services rendered. In terms of an S corporation, the shareholder-employee receives a paycheck (of sorts, since there is no requirement that it be issued on a regular basis) with payroll (and withholding) taxes deducted (and the other half being paid by the corporation) and a W-2 at the end of the year.

S corporations generally just issue Schedules K-1 on which income, gain, deductions, credits, et al, are passed through to the shareholder(s). You probably are already aware that the shareholders are taxed on the income passed through from the corporation regardless of whether there is a distribution, a distribution being nothing more than the transfer of money (or other property) from the corporation to the shareholder. 

[SCGI]

My figure comes from researching actual IRS cases.  The IRS in one case determined that $47,000 was too low, and in another determined that $50,000 was sufficient.  I think that my statement is valid based on actual IRS lawsuits.