S Corp Distributions: How Contractors Pay Themselves the Right Way
Is it OK to take money out of your S corp whenever you want?
Mostly, yes. But there are rules. Get them wrong, and the payroll tax savings that made the S corp worth it can disappear, or you can owe tax you didn't plan for.
Here's how S corp distributions work, in plain English.
What a Distribution Is
A distribution is money you take out of your S corp as an owner, not as an employee. It isn't salary, and it doesn't run through payroll.
As an S corp owner, you get paid two ways:
The Salary Bucket. A reasonable salary, paid through payroll. Social Security and Medicare taxes come out of it.
The Distribution Bucket. The rest of the profit, taken as distributions. No payroll tax comes out of it.
That second bucket is where the S corp savings come from.
Salary Comes First
The IRS expects you to pay yourself a reasonable salary before you take distributions. Reasonable means about what you'd pay someone else to do your job.
Why? Because without that rule, every owner would take $0 in salary and skip payroll tax completely. The IRS watches for this. An owner with big distributions and little or no salary is an audit risk.
There's no single number the IRS publishes. A good salary fits your trade, your hours, and your area. Put the reasoning in writing, and keep it with your records.
Distributions Aren't Taxed Twice
Here's the part that confuses most owners. Your S corp's profit shows up on your personal tax return through a form called a K-1, whether you take the money out or not.
You pay income tax on your share of the profit. That happens even if the cash stays in the business account.
The distribution itself usually isn't taxed again. You already paid tax on that profit through the K-1.
So taking a distribution doesn't create new tax by itself. Leaving profit in the business doesn't save you tax either.
Basis: How Much You Can Take Out Tax-Free
Basis is your running investment in the S corp. Think of it as your tax-free bucket.
It goes up when you put money in and when the business earns a profit.
It goes down when you take distributions and when the business has a loss.
It can't go below zero.
A distribution is tax-free up to your basis. If you take out more than your basis, the extra is taxed as a capital gain.
This is why your books matter. If nobody tracks your basis, you won't know when a distribution crosses the line.
When you take a distribution, you generally also have to file Form 7203 with your personal return. It shows the IRS how your basis was figured.
Distributions Have to Follow Ownership
If your S corp has more than one owner, distributions have to match ownership. If you own 60%, you get 60% of every distribution. Your partner gets 40%.
An S corp can only have one class of stock. That means every share has the same rights to distributions. Uneven payouts can raise questions about whether your business still qualifies as an S corp. If distributions get out of line, fix them quickly.
How to Take a Distribution
Make sure payroll ran first. Your salary for the period should already be paid.
Check the business can afford it. Leave enough for taxes, payroll, and slow months.
Transfer the money from the business account to your personal account.
Book it as a distribution. In QuickBooks, it goes to an equity account, usually called Shareholder Distributions. It's not an expense, and it's not payroll.
If there's more than one owner, pay everyone at the same time and in the same proportion.
Four Mistakes to Avoid
Taking distributions with no salary. It's the fastest way to draw IRS attention.
Booking distributions as an expense. It makes your profit look smaller than it is and throws off your tax return.
Not tracking basis. Take out more than your basis, and part of it becomes taxable.
Paying owners unevenly. It can put your S corp status at risk.
Key Takeaway: Pay yourself a reasonable salary through payroll first. Then take the rest as distributions, in proportion to ownership, and book them to an equity account. You pay tax on your share of the profit either way. Distributions are only tax-free up to your basis, so keep your books current.
Still deciding whether to become an S corp? Read S Corp Election for Contractors: How to File Form 2553 by March 15, or see what you'd save with the S Corp Tax Savings Calculator.
At Civita Tax Solutions, we help home service business owners save money on taxes with all-in-one accounting. We handle your bookkeeping, advisory, and tax filing. You focus on the business. We handle the finances.
Not sure your salary and distributions are set up right? Book a free consultation and we'll check them with you.
