S-corp accounting and tax and accounting - buffer amount for early next year

Question

I have single owner LLC taxed as S-Corp. I got an interesting question, let us say we have to keep some buffer amount to keep January expenses in the bank, how do we classify this for both accounting and taxation purpose for year 2022?

I am doing cash based accounting.

Based on what I read, it seems we keep this as "retained earning" (after paying the tax) (or) mark as profit distribution, but take the amount sometime mid February (by then we will get some payments from clients).

Any suggestions?

Answer 1

This is an accounting question (which are generally off-topic), but it is relevant to individuals operating as S-Corps, so would probably be OK to answer here.

S-Corps are not allowed to have retained earnings because S-Corps are pass-through entities and do not pay taxes themselves. So all the earnings have to pass through to the individual shareholders on their tax returns.

However, it is perfectly plausible that the actual money remains in the corporation and is not distributed, even though it was allocated to shareholders on the tax return.

The way it is reflected in the books is as if the shareholders received the distributions and immediately contributed back to the company. Since the distribution is proportional to ownership, so would be the contribution, and as such - in essence the share distribution doesn't change, but the basis does.

This then is reconciled on tax returns on the form 1120S Schedule M-2.

The February distribution, if in excess to allocated earnings, can then be treated as return of capital.

To learn more please talk to a EA/CPA licensed in your State.