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I am the sole shareholder and only employee of an S corporation. I understand that all profits of the corporation are passed through and taxed as income to me. I also understand that all dividends paid to shareholders are taxed at the lower capital gains level (and if I am wrong on this, please correct me.) Finally, I am paying myself a reasonable salary compared to my area.

Is there an easy way to understand how to figure out the minimum I should pay out in dividends such that I don't have to pay taxes on the profits as ordinary income?

Specifics:

  • Business Income before Expenses: $15,000
  • Payroll Paid: $7,000
  • Employer Taxes & Other Expenses Paid: $3,000
  • Remaining Credit Card Balance: $2,000

Does this mean I need to pay out $5,000 in dividends in order to avoid the tax on the profits? If I am not making any sense, please enlighten me... I'm learning all of this stuff as I go!

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Whoever voted-to-close: this is on-topic subject matter. How a self-employed individual realizes personal income from his operating company is an appropriate question topic. Refer to meta.money.stackexchange.com/questions/15/… –  Chris W. Rea May 29 '12 at 16:01
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1 Answer

up vote 4 down vote accepted

There are no dividends from S-Corp. There are distributions. Big difference.

S-Corps fill form 1120S and schedule K-1 per shareholder. In the schedule all the income of your S-Corp will be assigned to various categories that you will later copy to your personal tax return as your personal income. It is not dividend income.

The reason people prefer to take distributions from their S-Corps instead of salary is because you don't pay SE taxes on the distributions. That is also the reason why the IRS forces you to pay yourself a reasonable salary. But the tax rate on the income, all of it, is your regular income tax rate, unless the S-Corp income is categorized in a preferred category. The fact that its an S-Corp income doesn't, by itself, allow any preferential treatment.

If you're learning the stuff as you go - you should probably get in touch with a tax professional to advise you.

All the S-Corp income must be distributed. Its not a matter of "avoiding paying the tax", its the matter of "you must do it". Not a choice.

My answer was not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer (circ 230 disclaimer).

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thanks for the response... what you said makes sense and was very helpful. I am working with a CPA, but I don't like to bother her with ALL of my questions. When you say "All the S-Corp income must be distributed" does that just mean that all income must be categorized as income or a distribution? –  Ryan Ferretti May 29 '12 at 21:58
    
@RyanFerretti what do you mean you "don't like to bother her"? Isn't it why you're paying her? That's her job to answer your questions! "all income must be categorized as income or a distribution" - all income is income. Distributions is everything that is net income. S-Corp cannot retain profits, so whatever is left in your accounts must be distributed to the owners (you don't have to physically withdraw it, you can add it to your basis instead, but you must report it as distributed and pay taxes on it). –  littleadv May 29 '12 at 22:14
    
makes perfect sense... I come from a developer background so I guess I like to research things on my own... I would definitely contact my CPA if the issue was more pressing. Hopefully this discussion helps someone else. Thanks again! –  Ryan Ferretti May 29 '12 at 22:16
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@RyanFerretti can't imagine a client coming to you with app specs, but not asking about deployment because she "doesn't want to bother you with the little things"... Can you? :) Anyway, good luck in your endeavors. Debugging apps is much easier than debugging tax returns. Better to make it right upfront. –  littleadv May 29 '12 at 22:20
    
haha... great point! –  Ryan Ferretti May 30 '12 at 13:43
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