Expert: Mike Wellman - 12/3/2008

Question
Hello and thank you for taking my question.

I own an S-Corp, and in addition to payroll, when I need to get cash into my
personal account, I do a profit distribution by writing a check to myself.  This
money is not taxed, obviously since it does not run through payroll, but how
is it taxed at the end of the year?  Is it profit?  Is there a better way to give
myself money for personal use?  Sometimes cash flow does not permit me to
run a higher payroll.

Also, again due to cash flow, I will have a profit in the corp this year, and
cannot zero out with bonuses or expenses.  What happens to that profit?  
How is it taxed?

Thank you!  

Answer
The distributions, since they are not deductible, increase the net income of the S Corp and that profit flows thru to your K-1 and is picked up on your Schedule E. You pay tax on it then. By doing this, you avoid paying FICA/medicare on  it but run the risk of the IRS reclassifying it as wage income. You have to make sure your salary is appropriate for your title, duties, training and education and that the distributions are not out of line in  comparison to your salary.

For example, assume therefore your salary,  your net income is $200,000. If you took  out $20,000 in salary and the rest as a distribution, you have a problem. If  it is closer to 50/50 you may be OK. It depends on what you do, what others are paid in similar jobs, etc.