Got questions on how you can disperse company profits to yourself and your fellow business owners? Well, we’ve got answers for you: one of the most common ways to do this for C corporation owners is through dividends, and for S corp owners it’s through distributions.
Before we break down the difference between the two, let’s review a few key questions:
|What’s a shareholder?||An individual or entity that has ownership in a corporation. This ownership is usually in the form of shares of stock.|
|What is capital gains tax?||A tax on the profit made from selling an asset, like a share of stock. If you own an asset for less than a year, you’ll pay a short-term capital gains rate upon the sale; if you own the asset for more than a year, you’ll pay a long-term capital gains rate, which is generally lower.|
|How do C corps and S corps differ?||Both C corps and S corps have shareholders and give business owners liability protection, but there are a few important differences: |
C corps can have unlimited shareholders, while S corps can’t have more than 100. C corps can have international owners, but S corps have to be owned by US citizens. C corps can issue multiple classes of stock, while S corps can only issue one type. C corps can offer dividends to shareholders; S corps can offer distributions
Dividends vs. distributions: what’s the difference?
Both dividends and distributions are corporate forms of returning its income to its owners, but they’re used in different contexts.
A dividend is a portion of company profits—usually cash, but sometimes shares. A corporation may pay dividends to its shareholders. Unlike a salary, though, a dividend isn’t necessarily a predictable form of payment. It’s generally considered a reward or bonus if your company does well financially.
A distribution is also a dispensation of company profits—generally in cash—but it goes to the shareholders of an S corp, not a C corp. Similar to a dividend, a distribution is considered extra payment.
How are dividends and distributions taxed?
Because C corps are subject to double taxation, you pay taxes at the corporate and individual levels. Your company will pay income tax on your profits; then, once you distribute the dividends as payment, the shareholders who receive them will pay tax on them.
S corps, on the other hand, are pass-through tax entities (also known as disregarded entities), meaning that they operate like LLCs, partnerships, and sole proprietorships in terms of taxes. The company’s earnings are passed through to you as the owner then taxed on your personal income tax return—so you don’t have to pay corporate taxes.
As the owner of an S corp, you can generally take distributions tax free as long as you have sufficient basis in your company. Basis is a calculation of your financial contributions to the business, income, and distributions. If you receive distributions that exceed your basis, you may have to pay long-term capital gains tax on them.
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How to report dividends and distributions
It’s critical to accurately report the dividends or distributions you receive as a business owner; if you don’t, the IRS may penalize you with a fee.
If you have a C corp, you’ll report dividends on the 1099-DIV form. In an S corp, you report distributions on the Schedule K-1 (Form 1120-S) in Box 16. This form is specifically for S corps with shareholders, and it breaks down each shareholder’s income, gains, losses, tax deductions, and credits.
Before you fill out your forms, take the following steps:
- Get prepared with paperwork: To streamline the reporting process, it’s helpful to have the right information on hand. Gather your most recent business tax return, your company’s financial statements, and your articles of incorporation.
- Talk to your accountant: Reach out to your business accountant for help correctly reporting your dividends or distributions.