Shareholder Tax on Corporate Distributions

First, an important difference between S corps and C corps:

S Corporations

  • The shareholders of an S corporation pay tax on the earnings of the company.
  • Distributions of S corporation earnings are tax free to the shareholders.

C Corporations

  • The C Corporation pays the tax on the earnings of the company.
  • Distributions of C corporation earnings are taxable income to the shareholders (dividends).

What if your company was originally a C corporation and later converted to an S corporation?

The IRS requires that accumulated C corporation earnings be segregated from accumulated S corporation earnings. When accumulated C corporation earnings are distributed by an S corporation, the shareholders receive it as a taxable dividend.

Does your company have accumulated C corporation earnings on the balance sheet?  If so, distributions are subject to ordering rules. The default IRS treatment for ordering distributions is:

  1. S Corporation earnings (tax free to the shareholders)
  2. C Corporation earnings (taxable to the shareholders)

If the company exceeds the balance of S corporation earnings available to be distributed in a calendar year, the shareholders will incur a tax liability on the balance.

Often, the total available to be distributed is not known until after year end. A company that pays high distributions runs the risk of inadvertently making a taxable distribution to the shareholders. In order to minimize this risk, it might be advisable to defer end of year distributions until the beginning of the following year.

These are general rules and circumstances vary from company to company. For specific advice give us a call.

For more information, contact our office.

Sign Up for Our Newsletter...

Receive important updates, articles and tips, delivered straight to your inbox.