S Corp - When is your S Corp distribution taxable?

hey in this video I'm going to be talking about when our s-corporation distributions taxable and I'm going to address this in a very narrow and specific way so I'm not going to cover all distribution scenarios as I'll talk about here distributions what I mean by distributions is a payment to shareholders from their equity in the company not wages and often you hear people refer to that as getting a dividend from their company but you'll see that I don't I don't use that phrase lightly because the word dividend is actually a technical tax term that means a distribution from a C corporations earnings and profits that would be taxable for the person receiving it and so from a and so when we're talking in the context of accounting in tax the more generic term rather than saying I got a dividend the more generic term to use is to say that you've got a distribution from the S corporation so that's that's what I'm referring to is that payment from equity how are those distributions treated well that depends on the S corporations history did the corporation ever operate as a C corporation that's an important question here in terms and figuring out how a distribution may be treated for tax purposes a lot of times an S corporation was always an S corporation they elected to be S at corporate formation and so they never operated as a C corporation for tax purposes and that narrows the possibilities of how that distribution may be treated so here I'm going to discuss corporations in that zone corporations that always were treated as S corporation that we're never to dat C corporations I'll do another video at some point on what how you deal with S corporations that were previously C corporations because there's a number of factors including distributions to consider in that scenario but for today in this particular video I'm just gonna stick to this the kind of S corporation that was always an S never was a C and I'm also going to stick to talking about distributions that are made in cash which is the most common way to make a distribution to a shareholders to just pay them cash out of the company accounts it is possible to distribute non-cash property to literally give somebody an asset or a piece of property you might even distribute an intangible asset to a shareholder those are all possible transactions but they have different kinds of tax implications to them so for the purpose of this video I'm not going to jump into that I'm gonna stick with kind of the run-of-the-mill plain vanila you make a cash distribution from the equity of your S corporation a corporation that was always an S corporation what does that mean well as a reminder as corporations are generally not subject to federal income tax it's the owners that are subject the shareholders that are subject to income tax on that income the S corporation will file a tax return but it's an informational return it determines what the corporate income is and then it reports that to the shareholders who include that on their individual rataxes earns the exceptions that would cause a S corporation to pay a federal income tax revolve again around scenarios where that S corporation previously operated as a C corporation so that's something of how to get into in some other video the S corporation is going to report its profits to shareholders as I said earlier they do that the mechanism that they currently do that through on tax returns is called a schedule k-1 and then the shareholders take those k ones and they report that income on their personal return we refer to that as flow-through taxation and if you've ever been a partner in a partnership or familiar with partnership taxation you'll recognize that it's the same process for partnerships that partnerships are also have flow through taxation so S corporations like partnerships have flowed through taxation analyzing distributions the the topic here depends on a shareholders basis in their stock of the corporation now if your S corporation happens to be legally for state purposes an LLC that elected to be treated as a corporation an S corporation you have to basically tell attacks fiction you have to pretend as if your owners your LLC members don't just have membership units in an LLC but in fact have shares of stock in this fictional corporation because when you elected S that was the tax fiction you all agreed to to stick by for the purpose of determining the federal tax results so the shareholders tax basis and their share basically what that means is their after-tax investment in the S corporation and if you think about where that after-tax investment comes from it's money that they put into the S corporation after tax dollars that they earned or receive somewhere else in their life and then they put into the corporation that creates shareholder tax basis in their stock it is an amount that the shareholders should be able to draw out without paying tax because it's being established that stock basis is being established with these after tax dollars and aside from directly putting money in the other way that the shareholder gets basis is the corporation earns money which the shareholder is taxed on but the shareholder is not necessarily or excuse me the corporation is not necessarily required to distribute that money so that money that the shareholder has already paid tax on that the corporation is holding is retained earnings retained profits that the shareholders pay tax on and that would increase their basis and stock because their basis in stock is a measurement of their after-tax investment in the corporation so among other things of what I'm getting to what I'm getting at is that that basis number goes up or down with the company's income or loss so just like if the company earns money that the shareholder is taxed on the stock basis goes up if the company loses money or has losses that flow through and the shareholder takes to debt which ultimately should lead to the shareholder at some point getting a deduction for those losses that reduces their basis in stock now a complete discussion of stock basis is beyond what I want to get into in this in this video to keep it short enough for you all so I'll talk about soccer Jace's and some other and some other video with more with more details but the reason that I got into talking about stock basis is back to our main topic what is the tax treatment of a distribution from equity well distributions are measured against the shareholders stock basis so if the owner has basis then the distribution should be taxable the distribution basically you have basis it's like a bucket right and you put all this after-tax dollars in the bucket if you take money out of that bucket it's not taxable because it shouldn't be taxed twice so if you already pay tax on it you've got dollars in that bucket you should be able to take it out without paying tax again the distribution is gonna reduce the stock basis because if you follow my bucket analogy if you've got this bucket and you stuck a bunch of after-tax dollars in it and then you take money out of it that's your distribution we're saying that's not taxable because you had money to take out right okay but of course that reduces what's in the bucket so a distributions gonna reduce that that stock basis but once once you've made these distribute once once you've exhausted this bucket once there's nothing in the bucket you can't go below the bottom of the bucket you can't go to zero you can't go below zero so either have stock basis to distribute from or you just don't have any stock basis to distribute from stock basis cannot be less than zero so if the distribution exceeds the basis like if you go to take a distribution and there's nothing in your bucket there you know you come you didn't put any after-tax dollars in there or you've already taken them all out and you haven't earned any profits since you've taken them all out profits that were taxable so there's no there's no basis in there right so if there is no basis in the bucket then if you take a distribution it's toxic 'el now think about the underlying economics of this right so these are these are very technical tax ways of thinking about this result but it's a reflection of the underlying economics which comes down to this main point which is if as an owner investor you've already pulled out every dollar you ever put this business and you've already pulled out all the profits the business ever earned where's the cash coming from that you're pulling well it's either coming from what other investors put into the company or it's coming from debt it's coming from creditors who loan money to the company and you're pulling that cash out for yourself and that's essentially frames the tax policy here right because ultimately if your bucket has no tax basis in it if you have no after-tax dollars invested in this company at the time that you dip in and pull out a distribution that distribution becomes taxable that distribution that exceeds your basis in stock is treated as a capital gain for the owner on their personal tax return okay well I'm going to do more videos like this on S corporation operations and between gardening here so I will see you soon take care bye now [Music]

Channel: TCA

Views: 10,217

Keywords: tax, accountant, taxing, accounting, portland, oregon, garden, s corporation, s corp, entrepreneur

Id: _vSv8jBrMKI

Length: 9min 46sec (586 seconds)

Published: Wed Jun 26 2019