When it comes to taxes, complicated rules are the norm. So new shareholders of S corporations shouldn’t be surprised to learn that there are some seemingly illogical rules that will govern the way they’ll be taxed on corporate income.
As opposed to a regular corporation’s income, the income of an S corporation generally isn’t taxed at the corporate level. Instead, the income is “passed through” the corporation for inclusion on the shareholders’ returns.
No Cash, No Tax?
Under these rules, shareholders have to report corporate income even if it is not distributed to them. For example, let’s say an S corporation has two 50% shareholders and earns a $100,000 net profit in 2015. The company needs all its cash to fund operations and makes no distributions to the shareholders beyond their regular salaries. Each shareholder would still report $50,000 of income (plus salary).
Having to pay taxes on money that hasn’t been received may seem harsh. On the upside, the income will not be subject to taxes again if and when it is distributed. A “basis” calculation required under the tax law serves as a tracking mechanism to prevent S corporation income from being taxed twice. Shareholders receive basis for passed-through income and must reduce basis by cash distributions. Only distributions in excess of basis are subject to taxes.
Please let us know if you’d like more information about the S corporation rules. We’d be happy to explain them in more detail.
To learn more about S corporation income tax rules and regulations and how they affect your business, give us a call today. Our staff of professionals are always happy to help.