The first 10 years I was using S-Corp for "Side gigs". I did not take distributions or salary for like 8 years. The next 4 the income increased and I took a reasonable salary and very little distributions.
In 2019 I will probably net only $2000 because I did not do anything in the S Corp. I do not want to take a salary on $2000 as the fees are ridiculous for that little payroll.
My question is I have a lot of money from the last 14 years that I already paid taxes on. Can I take them as distributions (retained earnings) this year without a payroll in 2019?
It doesn't seem right if you earn $1,000,000 in a year and take $100,000 salary but leave the $900,000 in the account for future years that you would have to take a payroll in a year with no earnings just so you can access the $900,000.
It does make sense that you would have to take a salary in a year you are taking distributions IF you have net income to justify it.
A lot going on here and I will provide some commentary and guidance:
- Hopefully you filed tax returns for the S corporation. Once an S corporation is formed, a tax return is required each and every year regardless of the earnings. There are fairly significant penalties for failing to file tax returns, so hopefully this is not an issue.
- An S corporation is a passthrough entity. As such, the entity does not pay any tax (generally as there are exceptions). The S corporation provides the shareholder(s) with a K-1 and this information is then used by the shareholder when completing their respective 1040.
- Since the S corporation is a passthrough entity, and the shareholder reports all the earnings, gains, losses, etc. the shareholder needs to maintain a basis schedule of their investment. The starting point for this is the initial capital contribution and is then updated annually for the applicable items on their K-1.
- Since the earnings of the S corporation have already been reported by the shareholder and the applicable tax paid, the S corporation can make distributions to the shareholder. These distributions are not taxable to the extent that the shareholder has basis. That is why the basis schedule is extremely important to maintain.
- Having said that, the IRS is very focused on S corporations making distributions and little to no salary being paid to a working shareholder. The reason for this is the fact that the earnings on the K-1 are not subject to self-employment tax. As such, the IRS wants to make sure that sufficient social security is being paid in through paying wages.
- Your facts indicate that "I have a lot of money from the last 14 years that I already paid tax on." As noted above, these earnings increase your basis. However, as also noted above, there has been no social security tax paid in and that is an audit exposure.
- Using your example, if you earn $1,000,000 at the S corp level your basis increases by that $1,000,000. As a result, you are entitled to take a $900,000 distribution since you have sufficient basis without any further tax implications.
- You may want to consult with a tax professional to provide you with some additional understanding of the implications of S corporation tax and what you need to maintain (basis schedule, etc.).
Yes filed returns every year and have been using a Tax professional since Day 1 in 2005. I just don't get clear answers when I ask the questions so try to ask it to other people.
So as long as my basis is above $900,000 (yes I have basis schedule) then a $900,000 distribution in 2019 without a salary is still a huge red flag?
Every time you get a distribution in a year (even if you worked $0 hours in the S-Corp) you have to take a salary to be able to take a distribution? That doesn't seem right. For the years that I did have earnings I was taking a reasonable salary...there were other years where I would make $15000 but didn't take as salary or distribution so it just sat in account and increased basis.
What would happen if I would just close the S-Corp down - would that be easier to just get all the money out?
I guess my point is how do you get the money out on S-Corp that has been sitting in there for years doing nothing.
A couple of follow-up points:
- If you are not getting clear answers from your tax professional, then you need to make a change.
- In your example of working zero hours, there is no salary issue as you did not work so it is a moot point.
- For the years that you took what you deem a reasonable salary, then there should be no exposure. However, for the years in which you made $15,000 and did not take a salary, then you have exposure.
- Based on your facts, I would say taking a $900,000 distribution would (could) be a red flag. The reason is the K-1 isn't generating the kind of $$ that would seem to justify a distribution such as this. However, to address your specific question, as long as your distribution does not exceed your basis, there is no tax impact.
- There are benefits in using an S corporation, but that is not a discussion for a forum such as this. Additionally, there are most likely legal liability benefits to using an S corporation. Also not a discussion for a forum such as this.
- If you close the S corporation and just use a Schedule C for your sole proprietorship, all of your earnings will be subject to social security when you pay self-employment tax. Using an S corporation, one only needs to take a "reasonable" salary. This is subjective, especially since you appear to be the only shareholder and generating all the earnings.
- Find a tax professional who will take the time to help you understand what you have and if this is the right entity structure for you based on your facts.
Thanks for your questions.
My point of saying "Close S-Corp" is because of this situation. A lot of retained earnings that I struggle to feel comfortable taking out.
I sold an asset out of this business a few years ago and basically nothing left except cash/investment assets. The last couple of years I haven't done much with it so was thinking of closing and just starting a new S-Corp when I am ready for another venture. Doing investments in S-Corp is challenging at times and since my wife and I control 100% of it then it would be easier to just have money in our personal accounts.
When you say K1 is not generating income to justify a big distribution - that is my challenge - how do I ever get that money out if the K1 NEVER generates income again? Sounds like I would have to close S-Corp?
Just take the distributions over time instead of just one large distribution. Hopefully keeps you under the radar.