October 11, 2019 1:52 PM
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.).
*A reminder that posts in a forum such as this do not constitute tax advice.*