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S corporation payout rules


Dear Tax Talk,
For an S corporation with only two shareholders, are both required to have income reported on their K-1s? Is it permissible for just one to have income and dividends? Is the shareholder's income subject to self-employment taxes, and if so, is Schedule C used? -- Laura

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Dear Laura,
An S corporation is a corporation where the shareholders have elected (using Internal Revenue Service Form 2553) to pay the tax on the income of the corporation in lieu of the corporation paying income taxes.

The shareholders pay the tax by including their distributive share of income on their individual income tax returns. A Schedule K-1 is provided to each shareholder by the S corporation to inform them of the appropriate amounts of income and deductions to include on their income tax returns.

Only one class of stock can exist in an S corporation. Since the distributive share of income, deductions and dividends are paid in proportion to stock holdings and only one class of stock can exist, each shareholder's distributive share has to be reported in accordance with their ownership percentage. So it is not OK that only one shareholder has income and dividends. In fact, if dividends are not paid in accordance with stock ownership, the IRS can claim that the S corporation has more than one class of stock and thus the S election may be jeopardized.

A shareholder's distributive share of income and dividends are not subject to self-employment tax. The working shareholders of the company are considered employees and the company should file and pay payroll taxes on their salaries.

An individual shareholder's share of income is reported on page 2 of Schedule E and other appropriate forms as indicated on Schedule K-1.

-- Posted: June 15, 2004




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