How Are S Corp Distributions Taxed?

Say an S corp earns $200,000 before paying its only owner. It pays a $100,000 salary, for illustration, and $7,650 of employer payroll tax. That leaves $92,350 of K-1 income. During the year the owner takes $80,000 of distributions.

Now flip it. If the owner took no distribution at all, the $92,350 would still be on the K-1 and still be taxed. Section 1366 passes the profit through. Taxable income follows the profit, not the cash.

That catches new owners in both directions. Taking cash does not add income tax, and leaving cash in the company does not avoid it. Plan for the tax on the K-1, since distributions have no withholding. The IRS has shareholders pay this through estimated tax on Form 1040-ES, and our quarterly estimated taxes guide covers the mechanics.

These numbers are a hypothetical to show the mechanics. The salary is not a recommendation, and your figures will differ. To test your own profit and salary, use the S corp tax calculator.

Under section 1367 , income increases your stock basis. Distributions, nondeductible expenses, and losses reduce it, and it cannot go below zero. A distribution is measured after the year's income is added, under section 1368(d) , which is why a profitable year creates room.

Here is the same owner with $15,000 of beginning basis, under two distribution amounts:

Basis is a shareholder number, not a line on the company books. Retained earnings in QuickBooks and cash in the bank do not tell you what it is, which is why the rollforward needs to be kept year after year.

Form 7203 is the shareholder's basis schedule, attached to the personal return. The instructions require it if you:

• received a non-dividend distribution from the S corporation,
• are claiming a deduction for your share of an aggregate loss,
• disposed of S corporation stock, or
• received a loan repayment from the S corporation.

The order on the form: income first, then distributions, then nondeductible expenses, then losses and deductions. You can elect to apply losses before nondeductible expenses, under Regulations section 1.1367-1(g).

The company reports distributions on Schedule K, line 16d , and on each K-1. The K-1 reports the amount. It does not tell you your basis. That number is yours to support.

In the $115,000 column, $7,650 exceeds basis. Section 1368(b)(2) treats that as gain from a sale or exchange of property. If the owner has held the stock more than a year and sits in the 15% long-term rate, the federal tax on that excess is about $1,148, before any net investment income tax and state tax. For a single filer in 2026, the 15% rate starts at $49,450 of taxable income and the 20% rate starts at $545,500.

Debt basis does not cover this. The distribution rule looks to stock basis, so a loan you made to the company does not create room for a distribution. We walk through the fixes in S corp distributions in excess of basis.

Former C corporations have one more wrinkle. Accumulated earnings and profits (E&P) create a dividend layer:

The IRS says S corporations must pay reasonable compensation to a shareholder-employee before making non-wage distributions. Payments for the owner's personal services should be treated as wages, whatever you call them.

Illustration: an owner who works full time takes no salary and $180,000 of distributions. If $100,000 of that were recharacterized as wages, the combined Social Security and Medicare tax on it would be $15,300, before penalties and interest. Social Security applies to wages up to $184,500 in 2026, and Medicare has no cap.

How much salary is a separate question with its own evidence file. Start with our reasonable salary guide and the reasonable salary calculator. A percentage rule of thumb does not establish a defensible salary.

1. Confirm payroll is current for the owner, so the salary is in place.
2. Check your basis rollforward and, for a former C corp, the AAA and E&P balances.
3. Transfer from the business account to your personal account, by check or bank transfer.
4. Book it to a shareholder distributions equity account, not an expense and not payroll.
5. Pay every owner proportionately. See the warning below.
6. Set aside tax. Distributions have no withholding, and the K-1 income does not wait for your cash.

Cash is the simple case. Distributing appreciated property is not. The instructions value it at fair market value, and section 311(b) generally treats the corporation as selling it at that value, so gain can pass through to you with no cash from a sale.