Discussion:Taxing S corp net profit and distributions
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Discussion Forum Index --> Tax Questions --> Taxing S corp net profit and distributions
| 5 January 2007 | |
| I am new to the S corp business side of taxes. And sorely confused. When a shareholder is paid distributions, the payment only affects the Balance Sheet (isn't this correct?) My main question is this, if the distributions were paid to the shareholder, shouldn't the payment reflect somewhere on the P&L also to lower the net profit? Otherwise, the shareholder would be paying taxes on the distributions amount which is still showing in the net profit amount, and would have to pay taxes on it again. Help! | |
Mtmckeecpa (talk|edits) said: | 5 January 2007 |
| Dlp,
Distributions reduce equity, they are NOT a P&L item. The TP is taxed on their % distributive share of the P&L not the distributions too. Eg,...P&L shows $100k, distibutions of $80k...TP picks up the $100k from the K-1 on her Sch E, pg 2. | |
| 5 January 2007 | |
| But what about the distributions? Are they not taxed somewhere? | |
Mtmckeecpa (talk|edits) said: | 5 January 2007 |
| Dlp,
Generally, no. Distributions are just that...distributions of profits, not additinal income. If the TP distributes in excess of AAA then you might be taxed...but generally distributions are not subject to tax. | |
| January 5, 2007 | |
| In other words, the profit or loss is taxed, regardless of how much money is actually paid out. Think of....oh, mutual fund dividends/cap gains, many of which are used within the fund to buy more, but you pay tax as if it were paid, increasing your basis against the eventual distribution. | |
| January 5, 2007 | |
| Simplified example: S Corp. generates $100k of taxable income from the sale of services with no expenses - debit cash, credit income. At the end of the year, the income is passed through to shareholder (on sched. K-1) who pays tax on it. The income is closed to capital and the balance sheet has $100k of cash and $100k of equity. If a cash distribution is made - credit cash, debit equity. There is no P&L effect to the distribution - the shareholder has already paid the tax on the $100k of income when it was passed through to him on his K-1. If no cash distribution is made, the income is still passed through to shareholder on sched. K-1 and shareholder still pays tax on it. The $100k of income is tracked in the accumulated adjustments account (AAA) and may be distributed tax free in subsequent years. | |
Bottom Line (talk|edits) said: | 5 January 2007 |
| This is the big advantage of an S. The profit is only taxed once at the personal level. There is no federal tax on S Corp profits. In a C, the profit is taxed and then distributions/dividends are taxed again at the personal level (double taxation!). | |
| 5 January 2007 | |
| Thanks, I get it now. One more question, how do you set up the accumulated adjustments account? Is this a account in the companies chart of accounts? | |
Bottom Line (talk|edits) said: | 5 January 2007 |
| It's an Equity account | |
| 5 January 2007 | |
| S Corporation distributions must be in proportion to stock ownership. S Corps are only allowed to have one class of stock (even though some can be voting and some can be non-voting). Making disproportionate distributions could create a second class of stock and disqualify the Subchapter S status.
Also, shareholders should consider take some reasonable amount of payroll before considering distributions - if they have enough basis. | |
| 5 January 2007 | |
| The stockholder in this case is compensated as an employee bi-weekly plus a distribution monthly. This is the first year that income has been large enough to warrant distributions. The stockholder owns 100% of stock held, therefore proportion to stock ownership would not present a problem here, is this correct? Can you give me a debit/credit example of adjusting the AAA for distributions? I know that the distributions are debit cash/credit distributions equity account, but how does that work with the AAA as an equity account? | |
| January 5, 2007 | |
| AAA is an account of the S corporation and is not apportioned among the shareholders; accordingly, it cannot be an equity account. Because AAA is a cumulative account it has characteristics of an equity account; however, it is not tracked on the balance sheet, it is tracked on Sched. M-2 of the tax return. In very general terms, AAA is increased by tax income and decreased by tax losses/deductions and distributions. To the extent that this account is positive, distributions to shareholders can be made tax free (note: a detailed discussion of AAA could go on for pages - I suggest you take a look at Reg. 1.1368-2 as well as the examples contained in Reg. 1.1368-3 if you need more information.
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| 13 February 2008 | |
| It has to be on the B/S somewhere, maybe another equity account with different name like R/E...otherwise, how would you keep track of the balance in this AAA account... | |
| 13 February 2008 | |
| You keep track of it separately. It is not a part of the chart of accounts. | |
| 14 February 2008 | |
| I am not a CPA, but when I first started my own S Corp, I struggled with this question quite a bit, and due to the fact that none of the CPA's I went to would explain it to me, I started taking classes and researching it myself. Given that, what follows is the ordinary citizen interpretation (not the accounting-lingo) version that I had to come up with to understand it, and now use to explain it to my clients. S Corps have income and expenses. Expenses should include W2 wages paid to the owners in most cases, because they are employees and are separate entities than the S Corp. Beyond that, S Corps have profit (hopefully). This profit falls through the 1120S through the K1 and gets put on the 1040. The only way it shows up on the 1120 is the net, and of course the K1. If you don't take the profits out of the company, you should be tracking this AAA as a separate account. Then you can take draws out of this account, and they should not show up on your B/S at all (bc they aren't part of the income minus expenses calculation that the B/S is trying to do). Now, given your background, you probably think I'm some kind of an idiot making an over-simplified explanation, but that's the way us accounting-lingo illiterates think about it. | |
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