Understanding S-Corp Distributions and Draws | Are They Taxable?

Understanding and navigating the tax implications and responsibilities of business income is crucial for every business owner, especially those operating as an S-Corp. A very common question that often arises is whether or not S-Corp distributions and draws are taxable. In this blog post, we’ll answer this question and explore the key considerations of S-Corp taxation.

What Are the Benefits of an S-Corp?

First, it’s important to understand the benefits of operating a business as an S-Corp. S-Corps provide a unique level of flexibility with money, as there is a single-level of taxation on income generated by the corporation. This differs from C-Corps, in which profits are taxed at both the corporate and individual levels. 

In an S-Corp, income “passes through” to the shareholders, meaning it is subject to tax on the shareholder’s individual income tax return, not the business’s. 

Are S-Corp Distributions and Draws Taxable?

Now, let’s answer the burning question of, are you going to be taxed on distributions and draws from an S-Corp? The short answer is… no! 

Generally, you are not taxed on distributions and draws, which is one of the most significant benefits that an S-Corp offers. 

However, the key to all of this is to pay yourself a fair and reasonable wage as an S-Corp shareholder. The IRS requires you to compensate yourself adequately, and once you have paid yourself a fair and reasonable wage, you are free to distribute or take the remaining profits out in draws. 

Avoiding Payroll Tax Pitfalls

Keep in mind that as your profits increase, it’s not recommended to increase your payroll. Why? This leads to higher payroll taxes! However, S-Corp distributions are not subject to these payroll taxes, making this a better option for business owners looking to maximize their income without taking on additional tax burdens. 

Distinguishing Distributions from Profit

Distributions are essentially the sharing of profits among shareholders. The benefit is, you don’t pay taxes on the distribution itself, just on the profit that it represents. This is key to remember when understanding the tax implications of S-Corp income. 

Before taking out distributions as an S-Corp, you must have actual profits to distribute. Therefore, business owners must track and manage their profits effectively in order to benefit from distributions come tax time. 

Avoiding Tax Issues

When taking out S-Corp draws, ensure that you are taking out actual profits, not loan money, such as that from the SBA. This can have significant tax implications that can lead to complications and hassles down the road. 

Overall, S-Corp distributions and draws are not taxable. This makes S-Corps a great choice for small business owners looking to maximize their profits and save on taxes. Just make sure you stay up-to-date on the IRS guidelines, pay yourself a fair wage first, and ensure your distributions and draws are based on profits. This can help you make informed and smart financial decisions that benefits both you and your business long-term.