In a nutshell, S corporations pass through income and losses to their shareholders who, in turn, report the income and losses on their individual income tax returns (via their K-1s).
Retained earnings (RE) are more of an accounting feature and are not taxed. Net income will increase RE, net losses and distributions will decrease RE. The upshot is, if the corporation is profitable consistently but never actually distributes money or property (assets) to its shareholders, RE will increase.
