Double Taxation and Corporate Distributions

Learning Tax Differences Between Corporate Dividends and S-Corp Distributions

There are few instances of double taxes while paying taxes in the USA. Dividends are one exception to the double income tax rule. The cash paid by corporations in dividends is not a business expense. If your arts and crafts business pays you $500 in dividends, there is a reduction to the corporate checking account but no addition to expenses. Your business net income is not reduced. The $500 reduces your business equity.

This results in double taxes because the business net income is not reduced by the $500; so the corporation pays income tax on the $500. Secondly, you as the recipient of the dividend also pay taxes on the $500 when you file your 1040 for the year the distribution was made. The amount of taxes paid by the corporation and by you will most likely differ, as the tax rates for the corporation versus personal are different.

S-Corporation Distributions

In many cases, distributions made by an S-Corporation are not taxable to the shareholder. As long as you have adequate basis in the corporation, the distribution is tax-free. The same rules apply to the S-Corp as apply to the corporation for taking the distribution paid to S-Corp equity rather than an S-Corp business expense.

Figuring S-Corporation Basis

Figure your basis by adding many different dollar amounts. Here are just three of your possible additions to basis:

1. You purchase stock in your arts or crafts business
2. Any loans you directly made to the business
3. Ordinary arts or crafts business income you record on your 1040 via Schedule E

Here are two possible reductions to your basis:

1. Distributions the corporation makes to you in the current or prior years
2. Section 179 depreciation

Explaining the Non-Taxable Nature of the S-Corporation Distribution

Ok, per the above, distributions made by an S-Corp are not taxable. However, this is only because you’ve paid tax on all components of the basis already. The money you used to purchase the stock and make loans to the business came to you from various sources.

For example, the money may have come from W-2 income, investment income and lottery proceeds – the list goes on. Think back to when you received these sources. You paid tax on them at that time. Your S-Corp ordinary income is taxable on your 1040 in the year the S-Corp realizes the income. So while you don’t pay tax on the distributions when you receive them, you’re not getting a free ride on the distributions because the sources of the distributions were already taxed once.