Figuring Out Distributions at Tax Time

[grids]

This is regarding a two-person LLC filing as an S-Corp. Our previous accountants did not have us take regular distributions. My understanding is we had income, expenses, and the remaining was distributions to us. We typically didn't even know this dollar amount until we did taxes. We are both business and domestic partners, no employees, just the two of us, and we don't take a paycheck. TurboTax is asking me as the first expense for the distribution amount paid to us, before it has asked me for all of our business expenses. This seems backwards, once the expenses are input, then we will know our distributions. Won't working my way through Turbo Tax help me to ascertain our distribution amount?

[chines2]

Great question.  It is important to note that working shareholders in an S-Corporation should really be taking wages and not distributions.  This may explain why you are having difficulty figuring this issue out at year-end.  The Internal Revenue Code establishes that any officer of a corporation, including S
corporations, is an employee of the corporation for federal employment tax purposes. S
corporations should not attempt to avoid paying employment taxes by having their
officers treat their compensation as cash distributions, payments of personal expenses,
and/or loans rather than as wages.  This is something that a lot of small business owners are not aware of, so it is important to get on the correct track where distributions are concerned as it pertains to working shareholders.

In addition to the necessity to working shareholders to take wages, it is also important that the shareholders take a reasonable salary.  You will find it helpful at tax time once you do begin paying yourself wages, because you will have done the payroll tax withholding throughout the course of the year and save yourself from potential fines, penalties, interest, and late fees.

Hope this helps!

[grids]

The initial reply to this is great, for next year. How do I address last years taxes, in which we did not take wages or a salary? How do I figure the dollar amount that would have been wages?

[Mike9241]

This is no formula for what your wages should be. Many factors enter into determining what is reasonable compensation. factors include what others in a similar activity would be taking, where you live and work, hours spent. your best bet for guidance is tax professional in your area familiar with s-corp operations and compensation issues. 

there really is no way to make up for not taking salaries last year.  assuming the return has not already been filed, some might suggest reclassifying some of the distributions as compensation and issuing 1099s. You would be filing them late. As employees you are supposed to get w-2s not 1099s for your compensation.  In fact, doing this might increase your audit risk.