Still confused about dividends for an S corp

[pedz]

My attorney advised me to take the money I paid myself as a dividend.  (I have an email out to her as well but wanted to see if I can understand things better as well.)  The company is an S corp, has never been a C corp, but has paid dividends as late as 2004.  This year, I hit this Note from Turbo Tax which I don't recall before:

Note: Many owners think of cash distributions as "dividends" but only S corporations that were once C corporations or acquired a C corporation could pay out a dividend.

An AI search on Duck Duck Go gives this:

An S corporation typically does not pay out dividends in the traditional sense; instead, it issues distributions to shareholders, which are generally tax-free up to the shareholder's stock basis. If distributions exceed the basis, the excess is taxed as capital gains.

I paid $1000 for the stock back in 1994.  When I enter the amount into TurboTax, it now puts me into more screens that I've never seen before about Shareholder Stock and Debt Basis Limitations.

I'm fairly lost at this point.

[M-MTax]

You are supposed to take a reasonable salary for your services to the corporation each tax year and can pay yourself some amount from annual earnings over and above the amount of your salary. You pay tax on your S corporation's annual income (net profit) regardless.

Any excess you pay yourself, over and above your annual combined salary and distribution from earnings, is considered a return of capital and non-taxable to the extent of your basis (if the distribution then exceeds your basis, that portion would be capital gain).

[pedz]

I don't do much for the corporation at this point.  All of the income is interest which I guess is called "Portfolio" income at this point.

It appears I need to understand and fill out form 7203.  I'm reading the instructions now.  It all appears to be concerned about limiting the "losses" that I can declare as an individual and... I don't expect there to be any loses ever.

[M-MTax]

Exactly, because losses reduce your basis.

[ThomasM125 · Accepted solution]

The dividend your attorney mentioned is likely meant as a legal term more than as a tax term. For a normal "C" corporation, dividends are taxable to the recipient and not deductible by the corporation, resulting in a double tax. That is not normally the case with an S corporation, that makes distributions to shareholders, as opposed to paying dividends.

For tax purposes, an S Corporation will distribute profits to owners either as a payroll disbursement or shareholder distribution. You are normally required to pay yourself a salary commensurate with the services you provide to the company and its net income for the year. You pay tax on the net business income which includes a deduction for the salary you pay yourself. Then you can take distributions that are not taxed, as long as you don't take out more than your basis, which it your net investment in the company.

Your net income stated on the S Corporation return will not include the interest and dividends you mention, but they will appear on your Schedule K-1 form. As such, you will not need to pay yourself a salary to have them property reported. You can take a distribution equal to your net financial statement income, which will include the interest and dividend income. As long as you don't distribute more than the interest and dividends you should not have a problem with them being taxable as would be the case if you distributed more than your net investment in the business.

[pedz]

I think I am understanding everything better but wanted to add perhaps for my sake as well as to help anyone else following in my confused footsteps.

As mentioned, I'm plowing through TurboTax and it is asking me questions like "What are the Retain Earnings.  I look at my QBO (Quickbooks Online) balance sheet for the start of 2026 and put that number and it TurboTax says "Wait!!! That is way off!!".  But I finally click a little help link and it says:

How to Calculate Retained Earnings

Retained earnings means earnings of the corporation not yet distributed to its shareholders.

To calculate retained earnings from your books:
- Start with beginning retained earnings.
- Add current earnings or subtract current loss.
- Subtract shareholder distributions that are not booked as compensation or loans.

If you cannot find your book beginning retained earnings, use the amount on the 2024 corporate tax return (Form 1120S, page 4, Schedule L, line 24d).

So... I can't just use the QBO report.  I have to subtract what it called Retain Earnings from the Equity account I called Shareholder Distributions.  Yeah... Ok.  That's fine but golly geeze this seems much more obfuscated than necessary.