Shareholder Distributions (S Corporation)

Distributions are payments of cash or property from an S corporation to its shareholders outside of payroll. For an S corporation with no C corporation history, the rule is simple: distributions are tax-free up to the shareholder's stock basis, and any excess is taxed as capital gain. Distributions are not deductible by the corporation and are not subject to payroll or self-employment tax, which is the engine of the S corporation strategy, but they must ride alongside reasonable W-2 compensation for working owners. Two traps recur. First, distributions must be proportional to ownership; disproportionate distributions can be argued to create a second class of stock and jeopardize the S election. Second, distributions in excess of basis are taxable even when the bank account looks healthy, commonly after debt-financed cash or prior-year losses have drained basis.