How is S Corp Net Income and Distributions Taxed? Need Help Understanding the Difference

I recently became a shareholder in an S corporation and I'm trying to figure out the tax implications. I'm completely confused about how the ordinary business income allocated to me as a shareholder is taxed. I assume it's treated as personal income, but does it also get hit with self-employment tax like my previous LLC did? Also, I had lunch with another business owner who mentioned that distributions from an S corp are completely non-taxable as long as they don't exceed my stock basis. But when I started researching this online, I found what seems like contradictory information. I'm pretty confused about how distributions are treated by the IRS, especially regarding this stock basis concept. Can anyone help clarify how S corp income passes through to shareholders versus how distributions are taxed? I need to understand this better for tax planning purposes.

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19 comments

Freya Larsen

•8M

The difference between S corp income and distributions is a common source of confusion, so let's break it down: For the business income that flows to you as a shareholder: This passes through to your personal tax return and is reported on Schedule E. The important thing is that this income is subject to income tax but NOT self-employment tax. This is actually one of the big advantages of an S corp over an LLC taxed as a sole proprietorship. As for distributions: Your friend is mostly right. S corp distributions are generally not taxable as long as they don't exceed your stock basis. Your basis starts with your initial investment and increases with income allocated to you and decreases with losses and distributions. Think of it as a running tally of your already-taxed money in the business. The confusion might come from the fact that if distributions exceed your basis, then the excess amount is generally taxed as capital gains. Also, if you don't take a reasonable salary before taking distributions, the IRS may reclassify some of those distributions as wages subject to employment taxes.

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Freya Larsen

•8M

Yes, if your S corp makes $100k in profit, you'll pay personal income tax on the entire amount regardless of whether you take it as salary, distributions, or leave it in the company. That's the "pass-through" nature of an S corporation - profits pass through to shareholders for tax purposes even if the money stays in the business. Your basis would increase by the $100k of income allocated to you, decrease by the $30k distribution, and remain unaffected by your salary (since salary is a business expense already accounted for before determining the $100k profit). So in this scenario, your basis would increase by $70k ($100k income minus $30k distribution).

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Omar Zaki

•8M

Just wanted to share my experience with this exact issue. I was so confused about S corp taxation that I ended up using https://taxr.ai to analyze my corporate documents and K-1s. It helped me understand exactly how my business income was flowing through to my personal return and what was happening with my basis. The tool actually caught that my accountant had been calculating my basis incorrectly for 2 years, which could have caused huge problems if I'd been audited. It showed me exactly how each transaction affected my stock basis and what portion of distributions might be taxable. Their system walks you through all the S corp rules in plain English and helps you track your basis over time, which is super helpful for planning distributions.

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Omar Zaki

•8M

The system handles the calculations automatically once you upload your tax documents like K-1s, but you can also manually enter information if needed. It tracks both your beginning and ending basis for each tax year, showing exactly how income, losses, and distributions affected your numbers. For complex situations with debt basis, the tool actually separates stock basis from debt basis tracking, which was super helpful in my case. It flags when you're approaching a situation where distributions might exceed basis, and explains the tax implications. It handled both my shareholder loans and the corporate debt I had guaranteed.

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Diego Flores

•8M

I want to follow up on my skeptical comment about taxr.ai. I decided to give it a try with my complicated S corp situation and was honestly surprised at how well it worked. The system correctly identified that I had both stock basis and debt basis, and showed me exactly when I needed to track debt basis restoration before increasing my stock basis. It also flagged that some of my distributions last year were actually partially taxable because they exceeded my stock basis - something my accountant completely missed! The tool created a year-by-year basis tracking worksheet that I can share with my tax preparer now. Definitely cleared up my confusion about S corp taxation.

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Anastasia Ivanova

•8M

Hey, if you're having trouble understanding S corp taxation, I highly recommend using Claimyr (https://claimyr.com) to speak with an actual IRS representative. I spent weeks trying to figure out my basis issues, left messages for the IRS, and couldn't get through on their phone lines. Claimyr got me connected to an IRS agent in under 45 minutes who walked me through the exact rules for S corp distributions and basis calculations. You can see how it works here: https://youtu.be/_kiP6q8DX5c The agent confirmed that distributions aren't taxable until they exceed basis, but also warned me about some common audit triggers for S corps, like unreasonably low salaries compared to distributions. They also helped me understand how to track basis increases from business income and decreases from losses and distributions.

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Anastasia Ivanova

•8M

It's a priority calling service that helps you skip the long hold times. You pay them, and they wait on hold for you, then call you back when they have an IRS agent on the line. It saves you from having to sit on hold for hours. You're right that the IRS won't prepare your return for you, but they absolutely will answer specific questions about tax rules. The agent I spoke with clarified exactly how distributions are treated when they exceed basis and the documentation I need to maintain for basis tracking. They won't do calculations for you, but they'll explain the rules so you understand how to apply them correctly.

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StarStrider

•8M

I need to admit I was wrong about Claimyr. After posting my skeptical comment, I decided to try it since I was desperate to resolve a notice I received about my S corp distributions potentially being taxable. The service actually did connect me with an IRS agent in about 35 minutes (after I'd previously spent DAYS trying to get through). The agent confirmed that I needed to file Form 8082 to correct the basis reporting from my S corp, and explained exactly how to document my basis to show that my distributions shouldn't have been taxable. If you're facing S corp tax questions like the original poster, being able to get an official answer from the IRS instead of conflicting internet advice was incredibly valuable. Saved me from potentially paying thousands in unnecessary taxes.

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Zara Malik

•8M

No, a loan guarantee by itself doesn't automatically increase your basis. For debt to increase your basis, you generally need to be the direct lender to the corporation or have actually made payments on the guaranteed debt. Simply guaranteeing a third-party loan usually doesn't increase basis until/unless you're actually called upon to pay the debt. The rules are pretty specific - you need "economic outlay" where you've actually put your money at risk. If the bank loaned money to your S corp and you just guaranteed it, that doesn't increase your basis until you make payments on it.

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