What are the tax ramifications of providing corporate distributions to shareholders?

When giving or receiving a corporate distribution, it is important to understand the tax laws that regulate your actions. The following information explains what is considered a corporate distribution, and provides tips for understanding your options.

Means of Distributing Income

For corporations, taxes associated with distributions to shareholders generally fall under one of two options:

• An “S-corporation” typically pays no tax on its own; rather, income flows through to the shareholders, and they pay the tax personally. With an S corporation, there is typically only one level of taxation.

• A “C-Corporation” pays tax on its earnings at the corporate level. Then, a second tax is paid when those same earnings are distributed to the shareholders. This system is often dubbed “double taxation.”

Types of Corporate Distribution

Most corporate distributions are in the form of money, but they can also be distributed in stock or another form of property. 

Distributions by a corporation of its own stock are commonly referred to as “stock dividends” and “stock rights”.

Distributions of stock dividends and stock rights are generally tax-free to shareholders. However, stock and stock rights are treated as property and must be reported as income if any of the following apply to the distribution:

• Any shareholder has a choice to receive cash or other property instead of stock or stock rights.

• The distribution gives cash or other property to some shareholders and an increase in the percentage interest in the corporation’s assets or earnings and profits to other shareholders.

• The distribution is in convertible preferred stock and has the same result as in (2).

• The distribution gives preferred stock to some common stock shareholders and gives common stock to other common stock shareholders.

The government also regulates the taxes associated with certain types of transactions. The following are examples which can be considered as corporate distributions:

• Below-market loans: If a corporation gives a shareholder a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate, the interest not charged may be treated as a distribution to the shareholder

• Canceled shareholder debt: If a corporation cancels a shareholder’s debt without repayment by the shareholder, the amount canceled is treated as a distribution to the shareholder

• Transfers of property to shareholders for less than face-market-value (FMV): A sale or exchange of property by a corporation to a shareholder may be treated as a distribution to the shareholder.

• Unreasonable rents: If a corporation rents property from a shareholder and the rent is unreasonably more than the shareholder would charge to a stranger for use of the same property, the excessive part of the rent may be treated as a distribution to the shareholder.

• Unreasonable salaries:If a corporation pays an employee who is also a shareholder a salary that is unreasonably high considering the work they do, the excessive part of the salary may be treated as a distribution.

For more information on C-corps and S-corps, check out the article “Should My Company be an LLC, an S-Corp or Both?”.

How to Report and File

The IRS advises that corporations file IRS Form 1099-DIV for each shareholder to whom you have paid dividends and other distributions on stock of $10 or more during a calendar year by February 28 (March 31 if filing electronically) of the year following the year of the distribution.  If non-dividend distributions were made to shareholders, file Form 5452, Corporate Report of Non-dividend Distributions.

For more information, including when to send forms to employees, read Publication 542.

Resources

For the most current guidance on this and all tax issues, visit IRS.gov.
 

• IRS Publication 542 – Business Tax Information for Corporations
  Differences in Legal Structures
• Choose A Business Structure– IRS
• Choose A Structure– SBA