How to Access Earnings from Your S-Corporation?

When it comes to operating an S Corporation, one key consideration is how to appropriately access the earnings generated by your business.

While tax benefits and asset protection are significant advantages of forming a corporation, it is crucial to avoid commingling personal and business funds to maintain the protection provided by the corporate structure, especially in the event of a lawsuit.

So, how can you effectively withdraw money from your S Corp to cover personal expenses while ensuring compliance and maximizing financial benefits?

Let Us Explore the Three Primary Methods:

1. Take a Distribution:

Distributions offer a favorable approach to accessing funds from your S Corp. These payments are reported as “passive income” on your personal tax return, exempt from employment taxes. By choosing this option, you can save money on taxes. However, it is wise to consult with a lawyer or tax accountant to determine the most advantageous approach for taking distributions and addressing potential capital gains. (I have spoken about the salary-distribution mix in my previous newsletters).

2. Pay Yourself a Salary:

While S Corps allows distributions, the IRS requires that you pay yourself a “reasonable” salary to fulfill tax obligations. Determining what constitutes a reasonable salary can be subjective, but factors such as your qualifications, experience, workload, previous distributions, and dedication to the business are considered. Strive to strike a balance between minimizing your salary and meeting a reasonable standard. Think of it as paying yourself what you would pay someone else for your role.

3. Give Yourself a Loan:

Another method involves establishing a line of credit between yourself and your business. You can then withdraw cash as a loan against this line of credit. At the end of the fiscal year, you and your accountant can assess whether to convert part of the loan into a distribution or maintain it as a loan (bearing in mind the requirement to pay interest on the loan). Taking a loan from the corporation eliminates the potential for capital gains. However, be cautious, as the IRS may recharacterize the loan as a distribution, subjecting it to income taxes. Consult with both your lawyer and accountant to ensure proper documentation, such as a legally enforceable promissory note, to support the loan arrangement.

Navigating the process of withdrawing funds from your S Corp requires careful consideration and professional guidance. Collaborating with a lawyer and accountant will provide valuable insights into your specific circumstances and help you make informed decisions.

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