Is the owner distribution on a schedule K the same as owners pay?

[jburatti]

I'm trying to teach myself some basics of taxes and returns, so I can do them myself next year.  My wife owns a small LLC (S corp), which her accountant did taxes for last year (and will this year too).  While going through them, on the Schedule K line 6d is Owners Distribution (also listed again on the K-1).  Is this the same as what she took in pay from the business (is the K-1 essentially like a W2 but just for the owners pay?) and if so, how and where would I place that information on our personal returns?  I would assume NOT on  a schedule C on our personal returns (which is where my income is listed as I am also self employed) because her business taxes would be filed separately as past years, correct? 

Furthermore, I found this article here: http://smallbusiness.chron.com/shareholder-distribution-vs-payroll-59898.html that half way already answers this question, but it I didn't fully understand it and it did bring up another one. It kind of "implied" (if I understood correctly) that this income is tax avoidable as the article stated "this income is not subject to self-employment income for the recipient". 

So to sum up...

1. Is the K-1 her reported income which has to match on her/our personal taxes?

2. Where (what form) do we report that income on our personal taxes?

3. Did I understand correctly that this income could be tax avoidable?

[TomYoung]

I think the article explains things very well.

There are essentially two ways a S-Corp owner might receive cash from the company:

1) A wage or salary reported on Form W-2.  This income is subject to - naturally - income taxes and FICA.  And, as the article points out, the IRS expects that an S-Corp owner will take a reasonable salary.

2)Distributions from the business to the owner, reported as Shareholder Distributions.  These distributions are treated, in effect, as a "return of capital" and serves to reduce the shareholder's investment in the business.  Since this cash is "return of capital" it's not "income" and it's not subject to income tax or FICA or SE Tax.

It's easy to see that you'd want to maximize #2 and minimize #1, but of course the IRS knows this too, hence their position that failure to take a reasonable wage "can be considered a crime of tax evasion"

The S-corp structure is a "pass through" entity, meaning that the corporation pays no income taxes in its own name.  Instead the corporation's profit and financial activity is "passed through" to shareholders in proportion to their ownership.  Of course the corporation's profit is calculated after salary/wages and FICA paid to its employees, including your wife. 

To (overly) simplify, your wife has two sources of income from her S-corp: Her wage or salary and the corporation's profit.  Distributions of cash characterized as shareholder distributions are not income and, accordingly, are not reported as such.

Tom Young

[jburatti]

Thanks for the answer.  Forgive me as I am new at this and the whole question was for the point of learning.  This response educated me on the difference of income and distributions but I still have questions regarding my specific situation, or perhaps I didn't give enough info in my original question.  

I know one is technically not "suppose" to do it this way but she uses her business checking/debit card for both business AND personal purchases.  She does not physically pay herself with a paycheck.  When her accountant did her 2015 business taxes he (I assume) took the value of those "personal expenses" and entered that as a shareholders distribution for her.  Being that you stated that a shareholder distribution is not income, the way it was filed, is it taxable (all possible evasion issues set aside for the moment)?

Let me backup even further with some added information and questions.  Her 2015 business taxes were filed as explained earlier.  Our personal returns were done by a different accountant but has errors and needs to be amended.  The errors included it being a single return for myself with a status of married filing separately and 2 of our dependents not included. I am trying to amend that with TurboTax and completed everything else that needed to be changed correctly but don't know how or where to include (if it even has to be included) her "income/distribution" as it was earlier described.  To restate it, she didn't physically take a paycheck and all personal expenses from the business was listed under "shareholder distribution" in the business returns.  

So... does this need to be included in the amended returns?
Where/what form do I include it on if it does need to be included?
And is it "technically" considered return of capital and not income, hence not taxable?

[TaxGuyBill]

First, ask your wife to open a corporate bank account IMMEDIATELY and only use that bank account for corporate income and expenses.

Was the corporation profitable (what is in box 1 of the K-1)?
Did your wife also receive a W-2?
Does it appear that the corporation used all of her personal expenses as a deduction on the corporate return?

[jburatti]

In box 1 of the K-1 16,073
She does not receive a W2
It does not appear that her personal expenses were used as deductions for the business

Her gross sales were entered on the 1120S, legitimate business expenses were deducted, leaving the 16,073 listed as "Ordinary Business Income" on the same 1120S.  This is essentially what she spent on personal expenses and is the same amount listed on the K-1.

[TaxGuyBill]

It seems that the corporation was profitable and she received money from the corporation (via personal expenses).  That means she NEEDS to have a W-2, and all of the associated payroll forms and taxes need to be filed and paid.

Your wife needs to be on payroll and receive a W-2 for her "reasonable compensation" for her work.  If she is the only employee, has no major equipment, and no employees, most or ALL of the profit should be wages on her W-2.

If your accountant did not explain this to her, you NEED to find a new accountant.
<a rel="nofollow" target="_blank" href="http://taxexperts.naea.org/">http://taxexperts.naea.org/</a>

As for what to do now, I would recommend fixing things.  That requires quarterly employer forms (to pay Social Security and Medicare taxes_, Federal Unemployment, a W-2/W-3, and possibly some State requirements.  All of those involve payments, late penalties, and interest.  An amended S-corporation return would also be required.

The other option is to file the K-1 as-is and not do anything else.  That would subject the profit to income tax, but avoid Social Security and Medicare taxes.  If you do that, be prepared to be audited, as it is wrong and illegal (although with a small income like that, it may not catch the attention of the IRS).  If you do it again this year, you probably WILL be audited.  With a bank account that has both business and personal transactions in it, an IRS audit could be very bad.

Is there a reason why your wife made an election to be taxed as an S-corporation?  From you are saying, it seems like she had no idea what was involved, including the extra paperwork and expenses.    With a small profit like that, it seems quite unreasonable to be taxed as an S-corporation UNLESS you are paying for private health insurance (not through an employer) and are running the insurance through the corporation.  In that case, it MIGHT be advantageous.

[saltzman25]

I have a simple question that I cannot see me to find an answer for anywhere….

How are distributions paid?

I have been paying myself a fair salary each month. When and how do I take distributions?

Monthly along with my salary?

End of year when all expenses and profits are calculated?

And do I just write myself a check for this amount? 
Everything I read says that doe an Scorp, whatever is profit for the business at the end if the year is taxed on my individual return. Does this mean that I must pay this amount as distribution to myself?

I am confused about how much money should remain in the business account? If I pay myself distributions, I imagine there should still be money remaining in my business bank account. Is that amount taxed on my individual returns, or is the distribution taxed? 
If anyone could explain this better, I’d really appreciate it! Thank you!

[Rick19744]

This is an old thread and going forward it is best if you start your own new thread.

Some comments on your questions:

1. It is good that you are taking a salary, as reasonable compensation is required to be paid to employee-shareholder's.  "Reasonable" is not defined and is based on facts and circumstances.
2. Distributions, in general, are just paid out as a check; no withholding.
3. As an S corporation, the entity is a pass-through, and as such, in general does not pay tax at the entity level.  So you are correct, after completing the form 1120-S, you will receive a K-1 with your share of the earnings.  I am assuming based on your facts that you are the sole shareholder?  If so, then you will be taxed on the profits.
4. Most pass-through entities pay out distributions to cover shareholder taxes on their share of the earnings.  This is typically a combined figure of federal and state tax; ie 35% (30 federal and 5 state as an example).
5. There will be times that you want to take out more, but as you say, you need to leave sufficient cash in the company to run the business.
6. As a shareholder of an S corporation, you need to maintain your tax basis in the S corporation.  This is extremely important.
7. S corporations should be tracking their AAA (which is part of the form 1120-S tax return) and this account cannot go negative by distributions.  This is not the same as your individual tax basis.
8. As you can see, these pass-through entities can get complicated quickly, regardless of the size of the business.  As such, it may be good to have a one on one with a tax professional to get a good understanding of how the S corporation works from a tax standpoint.  

[Critter-3]

If you have been paying a monthly salary did you ALSO file the quarterly payroll tax reports AND make monthly payments for the withholding  taxes ?    If not RUN to a local tax pro to get this corrected ASAP  and  get all your questions about an S-Corp, wages and bookkeeping requirements answered.  Learning all about keeping corporate books  here in this forum is just not feasible.