Consider the following hypothetical:
- I start an S-corporation as sole owner and employee but contribute no initial capital or assets. My starting basis is $0. (My initial investment is my expertise, which alas is not monetarily quantifiable.)
- I pay myself a completely reasonable salary of $80,000 per year.
- The company invoices $130,000 for the year and has no expenses of any kind. (This isn't strictly true, but I want to keep it simple.) The company's portion of payroll taxes is $8,760 per year. This leaves a company profit of $41,240, i.e., (130,000 - (80,000 + 8,760)).
My understanding is that I will pay income tax on that $41,240 as a part of my total gross income, i.e., $80,000 + $41,240 = $121,240. I'd then take the usual deductions and figure out the income tax.
Now, here's the confusing part. Since my basis for the year is $0, my understanding is that if I distribute that $41,240, I also have to pay capital gains tax on it, since it is above my basis. This means I would be double-taxed on it, paying income tax and capital gains. This just does not seem right, but every example I read online seems to imply this.
Do I have to pay income tax and capital gains on distributions when my basis is $0?