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S Corporations, which are companies granted a special tax status as specified under the Internal Revenue Code, have a different set of regulations when it comes to deducting distributions.

 

Distributions to shareholders of the company are tax free to the extent of stock basis of the shareholder. If the S Corporation makes distributions in excess of stock basis, the excess amount will be taxable to the shareholder. There are certain ordering rules that apply which will affect the taxation:

 

  1. Accumulated adjustment account: tax free up to stock basis- any excess is subject to capital gain rates.
  2. Previously taxed income: tax free up to stock basis- any excess is subject to capital gain rates
  3. Earnings and profit: ordinary dividend tax rates
  4. Other adjustment account: tax free up to stock basis- any excess is subject to capital gain rates
  5. Remaining shareholder's equity account: tax free up to stock basis- any excess subject to capital gain rates

However, there are few elections that can slightly change the ordering rules. For more details on modifying the distribution ordering rules, please contact your Rea advisor.

 

-by Kathy Davis, CPA (Medina office)


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