An S-corp shareholder can expect periodic distributions of income from the company and will have to pay tax on that income, using personal income tax documents. Additionally, shareholders can be provided with ancillary benefits with tax incentives, such as deposits in tax-free retirement accounts. Individuals who are shareholders of an S company should be aware that they are required to make quarterly estimated tax payments if they want to avoid tax penalties regardless of whether their distributions have already arrived.
S companies are organized under a pass-through accounting method, in which the money earned by the company is paid immediately to the shareholders, in proportions appropriate to their percentage of ownership. Under the United States tax code, an S corporation must have fewer than 100 shareholders, all of whom accept the classification as an S corporation and must be citizens of the United States. These shareholder-employees may include friends and family of the founders of the company.
Each employee-shareholder of S-corp is paid a “reasonable” salary, in addition to receiving benefits. Salary deemed “reasonable” is not set in stone, but is generally based on what people in similar positions would earn. Someone serving as CEO, for example, should have a salary comparable to that of a CEO in a regular company. If shareholders are offered unusually low salaries, this will be a red flag for the tax authorities and everyone is expected to receive at least one compensation, even when the company is losing money.
The shareholder of S-corp is subject to tax liability for salary income as well as for distributions of the company’s earnings. People also have to pay Social Security and Medicare taxes. An accountant can help people determine their tax liability and generate documents for estimated tax payments to facilitate the submission of those payments. If overpayments occur, the overpayment can be claimed on a tax return and will be returned to the S-corp shareholder by the Internal Revenue Service.
An S-corp shareholder should be aware that even if the income is not distributed, there is still a tax liability. In general, companies have rules that people must receive enough in their distribution to cover estimated taxes, to address this possibility. As shareholders, people are also expected to vote on matters relating to the functioning of the company. It is important to carefully examine the issues brought to the vote to ensure that they are fully understood. If there are any questions or concerns, they should be discussed before the vote.
Author: Joshua Newman
