Is paying back paid-in capital taxable income to me?

[SCORP2]

I'm a single member LLC taxed as an s-corp as of 1/1/22.

All income this year was used to build a free-standing office building.

Since the income alone was not enough to cover the cost, I put personal money into the business to cover the extra cost for it.

As such, I didn't pay myself any salary as any income was also used to build the office building.

And I still have paid-in capital invested I would like to be paid back for. 

Question 1: Is it ok that I didn't pay myself salary all year since I used all income to build the office?

Question 2: Does the fact that the office building have to be depreciated over 39 years make me owe taxes on the business income, even though I couldn't pay myself anything? 

Question 3: If in 2023, I pay myself back from paid-in capital,  are those payments tax free and not considered distribution? What would those payments be called?

Thank you so much for your time!!

[Mike9241 · Accepted solution]

Question 1: Is it ok that I didn't pay myself salary all year since I used all income to build the office?

probably not ok. you evidently had a business in which you were active.  the fact that all income was used to build is irrelevant. however, it's up to the IRS, if and when you are audited, to determine what it thinks reasonable compensation should have been. you then have the opportunity to contest their findings but this means tax appeals or tax court and that could get expensive.  

Question 2: Does the fact that the office building have to be depreciated over 39 years make me owe taxes on the business income, even though I couldn't pay myself anything? 

not really. had you taken a salary the S-corp income would be down by the amount of any salary but from your tax standpoint your tax on the S-corp net profits and S-Corp net income.  however, the effect of not having any earned income could affect your taxes - for example possibly no retirement plan contribution. 

some states tax S-Corp profits so you could end up paying higher state taxes on the S-Corp earnings. 

Question 3: If in 2023, I pay myself back from paid-in capital,  are those payments tax free and not considered distribution? What would those payments be called?

as an aside, some states impose a franchise tax based on stock and paid-in capital. additions to paid-in capital are supposed to be reported either within a certain time frame of doing it or annually. I wouldn't know if your state has such a tax. check with a local attorney. 

from a tax standpoint, the money taken out is a distribution that reduces retained earnings, not paid-in capital (proper accounting) to be reported on your k-1.  taxability depends on your basis in the S-Corp.  the money you put in increases your tax basis.   have enough basis and they're not taxable but do reduce your basis. 

. 

[Rick19744]

A few follow-up comments:

• Question 2 - An S corporation is a pass-through entity.  This means, in general, it is not subject to tax at the entity level.  As such, all income, gain, loss, etc., is passed -through to the shareholder.  Based on the limited facts, it appears that the business is generating income (profit) and this income is being used to build a building.  If the S corporation generates income in 2022, then that income will be passed through to the shareholder and the shareholder will need to pay tax on that income.  So effectively, the answer to your question is probably "yes"; you used the assumed profits to build an asset and did not distribute out cash to cover your potential income tax.
• Question 3 - you need to meet with a tax professional to make sure you understand how S corporations work.  There are many nuances with an S corporation.  You will need to track the accumulated adjustments account (AAA) and your tax basis and these figures will determine the tax impact of any distributions.  Retained earnings in an S corporation environment have no impact on how distributions are taxed.  As an S corporation the key components are whether there are sufficient AAA first and then the sufficiency of tax basis.
• In general, you will need to understand how to track your tax basis in your S corporation investment.  This is a key for determining the tax impact of your pass-through items on your annual K-1 and eventual sale or disposition.