S Corp ordinary income vs distribution

[JBP]

When is money taken out of an S Corp a distribution and when is it just passed along as ordinary income from line 21 on 1120S?

I have an S Corp owner (100%) who pays herself a reasonable salary, but also takes a lot of 'draws.' Under what circumstance would these be reported as distributions vs being allowed to just flow as ordinary income from line 21 to K-1 line 1?

With a sole proprietor, it doesn't matter whether the owner takes money out or leaves it sitting in the business account -- s/he is taxed on the net profit.

How is this different with a single owner S Corp?

I basically apprenticed with someone who I now believe cut corners (never kept a balance sheet for any business, etc) and I'm questioning a lot of what I learned from him.

[kathyc2]

I believe you are confused on terminology.
Revenue over expenses (which includes SH salary) is what produces ordinary income. This is also known as net income.
This is taxed to SH on their 1040.
Ordinary income increases equity (retained earnings).
Dividends or what you are calling draws is a contra equity account and reduces equity. Dividends do not effect current year ordinary income.
If dividends taken exceed the equity account, they are no longer tax free.

None of the S-corps keep records on a QuickBooks type program? QB will produce a balance sheet which is Sch L on 1120S. Even if the S is small enough that a Sch L is not required, I think it's a good idea to report it for tracking purposes.

[JBP]

Thank you for this, kathyc2 -- it matches my understanding.

I'm just hung up on this piece:
My client took money out of the business (above her salary) and told me it's a distribution. I'm not sure if I should literally report it as a distribution, or whether that amount just becomes part of the ordinary, or net income/loss.

[spanel]

Thank you for this, kathyc2 -- it matches my understanding.

I'm just hung up on this piece:
My client took money out of the business (above her salary) and told me it's a distribution. I'm not sure if I should literally report it as a distribution, or whether that amount just becomes part of the ordinary, or net income/loss.

Distributions have nothing to do with profit/loss. If the distributions exceed basis, then the difference is a LTCG.

Chris

[kathyc2]

I'm just hung up on this piece:
My client took money out of the business (above her salary) and told me it's a distribution. I'm not sure if I should literally report it as a distribution, or whether that amount just becomes part of the ordinary, or net income/loss.

Why would you think that owner taking money out would be a business expense? The only way that would apply is if SH paid business expense with personal funds and Corp reimbursed them.

[Maude Lebowski]

JBP, Yes, you literally report it as a distribution. (NOT as a dividend, which is another matter altogether.) I recommend studying an S-Corp shareholder basis worksheet in order to understand profit, loss, distributions, etc. and their effects on basis. Your tax software should have one. However, to put it simply, say there is $1,000 in ordinary income/profit. The shareholder reports and pays tax on $1,000. They now have $1,000 in basis. If they take a $1,000 distribution it is "tax-free" because the tax was paid when the income was reported.

[Rich]

Distributions have nothing to do with profit/loss. If the distributions exceed basis, then the difference is a LTCG.

Chris

What if there is little / no basis, S-Corp is an individual 100% owner. Has $100,000 net income, pays himself $40k salary, then during that same year (end of year) takes $20k distribution. Is that 20k treated as STCG?

[spanel]

What if there is little / no basis, S-Corp is an individual 100% owner. Has $100,000 net income, pays himself $40k salary, then during that same year (end of year) takes $20k distribution. Is that 20k treated as STCG?

Never a STCG. Always a LTCG.

Assuming basis started at $0
Assuming net profit is $100000 - $40000 salary (would also look at reasonable salary if thats the case)
Basis is $60,000 - $20,000 = $40000 left in basis, no LTCG.

If basis basis below zero, that number is taxed as a long term capital gain.

Chris