equity, taxes, s-corporationI own a small business (S-corp). If I take an equity draw from from the company, as opposed to a dividend or cut of the profit, do I have to declare what I receive from the equity draw as income on my personal tax return? My personal thought is no because the money taken out of the company I had originally put there from my personal finances–like putting money in a bank and later withdrawing it–so it wouldn’t be re-taxed. I’d like to get others’ thoughts on this.
That sounds perfectly logical… which means that the IRS will probably disagree. :)
That said, the type of business, the year that the money was invested vs. the year it was withdrawn, and a thousand other factors could come into play. At the very least, it should affect your capital gains calculations. In other words, the draw may not be taxable, but the increase in your portion of the business equity that made the draw possible almost certainly is. And yes, they can tax the business for making money and then tax you for owning something that increases in value.
You are going to have to deal with a tax accountant eventually, might as well start that relationship now.
First let me make a couple of premises, your corporation has always been taxed as a S-Corporation and your company makes a profit excluding any amounts for you. Also let me change your term “equity draw” to a more a more general one “distribution”. In that case, the technical answer is “yes”, you can take a distribution and it is not taxed. But, that answer is totally misleading. An S- Corporation is a hybrid organization. It is a corporation formed under state law. As such, it is just like every other corporation formed under that state law. However, the shareholders make an “election” to be TAXED as an S-Corporation. Taxation as an S-Corporation is very similar to that of a partnership, but it is not the same. The largest similarity to a partnership is that income is taxed only once. The shareholder, like the partner, reports the income and pays the tax. All the income (with some special exceptions) and most expenses of the S-Corp are reported to the shareholders on a K-1, and taxed with their other income. It does not matter whether or not any money is taken by the shareholder. The initial investment plus the corporations income and expenses makes the “stock” equity of the shareholder in a S-Corporation. Distributions and losses reduce the equity. Note sock equity is not just the amount listed as stock on the balance sheet.
Since you have to report all the income in your tax return, regardless, whether or not you take any money, any money (distribution) you take is not taxed as such. It is already being taxed. You can call any money distributed to you an “equity draw”. Now what I have stated is very simplistic, real situations might have different results.
There are many tax rules for S-Corporations and many are complex. Here is a Forbes article about the taxability of S Corporation distributions. If your situation is different than from my presumptions, the article may give you the answer to your situation. You might think the article is complicated, however in fact it is merely a summary. If you wish a more simplified answer than one in the article, please revise your question.
http://www.forbes.com/sites/anthonynitti/2014/04/08/tax-geek-tuesday-are-those-s-corporation-distributions-taxable/
If your company is making a profit and you are wanting to be paid with an non taxable “equity draw”. You can’t. All the flow-thru income and expenses must be reported on your K-1 and included in your tax return. Also if your company is making money, you should take at least a small salary. If you choose not to, you are a target for the IRS. Hire a tax accountant if you want to tweak your compensation and not get in trouble.
http://www.nolo.com/legal-encyclopedia/s-corporations-salaries-an-irs-hot-button-issue.html
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