New S Corporation business owners often ask me how to get money out of their business account and into their personal banking account.
Basically, there are four different ways to take money out of an S Corporation. In today’s post, I’ll outline how to get money out of an S Corp and what you should avoid during these transactions.
First of all, if you haven’t determined how much you’ll earn, you need to get that done immediately. This is not a decision to take lightly. In fact, there are lots of important factors to consider when deciding upon your salary. To get this right, I recommend completing an S Corporation Reasonable Compensation Report.
Once you have that amount in mind, I recommend that you set up your payroll. Remember that as an S Corporation shareholder and employee, you still should receive a regular paycheck, withhold taxes, pay taxes, and receive a W-2.
If you need help with any of these steps, I’ve outlined exactly how to do payroll for a single member S Corp in a separate blog post.
The wages you pay yourself will be the biggest way that you are financially rewarded for your hard work, so take the time to closely consider this amount. Just like any other company would, you should also revisit your wages–as well as your employees’ wages–on an annual basis.
Unlike C corporations, earning distributions–also called dividends–are not generally handed out to S Corporation shareholders. Instead, S Corps distribute earnings to shareholders (that’s you!) as non-dividend distributions. I recommend that the amount an S Corporation’s owner takes in distributions should not be more than her salary.
The best news? The distributions your S Corporation makes to you are not subject to Social Security or Medicare taxes (commonly called FICA taxes). This is true as long as the amount of the distribution isn’t more than your “stock basis.”
Remember that S Corporations are “pass through” entities, so your income is only subject to a single level of taxation. This taxation happens on your personal income tax return. Just beware, however, that if the distributions you receive are more than your “stock basis,” the excess amount will be taxed as a long-term capital gain. You don’t want this.
If you’re wondering what your “stock basis” is, that number is determined by the yearly completion of Schedule K-1 (Form 1065) as part of your S Corporation’s federal tax return.
Basically, to determine your stock basis, you’ll take the amount you paid to buy stock in your company, add your share of the business’ net income, and then subtract your share of any net losses or distributions you’ve received from the business.
If your eyes just glazed over, work with a CPA to keep track of this for you.
Another exception to S Corporation members not paying taxes on dividends would be if your S Corporation was originally a C corporation. In this case, when the business is converted, any earning distributions from the original corporation would be subject to dividend or long-term capital gains taxes.
Warning: I know you are a savvy business owner, and you just read that bit about distributions not being taxed as heavily as wages, and the lightbulb went off above your head, right?
If you’re thinking that you can change some of your wages to “distributions” in order to avoid paying all of those taxes, the IRS knows that game, and they will win that game. It’s best to set a reasonable wage based on research and then take your distributions as they come.
If you are purchasing business-related items, of course you should use your business banking account to do so. However, there are times when you might use your personal banking account to make business purchases with the intent of reimbursing yourself with the business’ money. That is totally fine. Just make sure that you have documentation to support the reimbursement.
If you’re running short on cash or have an unexpected expense on the homefront, you can borrow money from your S Corporation. However, you can’t simply just scribble out an IOU or do a quick transfer of money between accounts. You will need to obtain an official promissory note that is properly prepared and executed. The note should contain information about the date of repayment, the fair market interest rate being charged, and an unconditional promise to repay.
There are many advantages to owning an S Corporation, so don’t let figuring out the finances and taxes hold you back. If you’re feeling overwhelmed, definitely contact a tax professional. Then, take a deep breath, and know that you have this under control.
- Determine a reasonable salary for yourself.
- Consider how you will distribute earnings to yourself in addition to your wages. Remember my recommendation that your distributions should not equal more than your wages.
- Always keep accurate records of any money transactions between your business and personal banking accounts.