S corporations can make cash outlays for wages and shareholder distributions. Shareholders can also receive salaries as employees, and excess profits can be distributed at the end of the year. The special tax status of S corporations means that they pay no tax on earnings, passing profits and losses on to shareholders. The Accumulated Adjustment Account (AAA) determines how profits and losses are allocated for tax purposes, which may differ from the percentage of shares owned. Traditional dividends from a retained earnings account are not treated as part of S corporation distributions for tax purposes.
The two types of ordinary cash outlays that an S corporation may make for accounting purposes are wages and shareholder distributions, sometimes imprecisely referred to as dividends. This type of company is a US structure with special tax rules set by the country’s Internal Revenue Service (IRS). To maintain its special status, an S corporation can only have 100 shareholders or fewer, but those shareholders can be owners and employees of the corporation at the same time.
If a shareholder of an S corporation decides to work for the corporation, he or she can receive a salary as an employee. The company would pay the shareholder for his services out of the earnings, and both the employee and the company would pay applicable employment taxes on payroll. Paying stockholders who work for the corporation is an important part of an S corporation distribution policy because the IRS looks askance at owners who extract earnings from an S corporation when no one is listed as an employee of the corporation to pay taxes on the Work.
S corporation distributions also include disbursement of excess profits to owners at the end of the year. The company may make a lump sum distribution of profits to shareholders in proportion to the shareholder’s distributive interest as represented by their Accumulated Adjustment Account (AAA). The special tax status of an S corporation means that the corporation pays no tax on its earnings. Instead, it passes profits and losses on to shareholders, who record their share of personal income taxes and pay taxes on it at the individual tax rate.
The AAA is not necessarily tied to the amount of shares held. An S corporation’s ownership, or the percentage of shares allocated to shareholders, can be different from how profits and losses are allocated for tax purposes. In short, a person may own 50 percent of the outstanding stock of an S corporation, but be entitled to only 25 percent of the distributive profits or losses. For this reason, Company S’ distribution policy might call a distribution a dividend, but it is not a dividend in the traditional sense. A dividend is a payment of retained earnings on a per-share basis, usually in very small amounts and at various times throughout the year.
If Corporation S was converted from Corporation C, it may also distribute a traditional dividend from Corporation C’s retained earnings account. These dividends are not technically treated as part of Corporation S’s distributions for tax purposes since they come from retained earnings and not from the AAA. This distinction is often confused by the layman, but is very important for tax purposes.
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