An S corporation is a pass-through entity and does not pay federal income tax. All profits, losses, and other pass through items are allocated according to each shareholder’s proportionate shares of stock.  Each stockholder will receive a “K-1″ tax form indicating the stockholder(s) pro-rata share of profits. The shareholder(s) report their share of profit on their individual income tax returns. Generally, an owner of an S corporation also performs services for the company. This makes him to be both a shareholder and an employee of the company.  There are basically five ways you can get money out of the company:

• Wages
• Distributions of profits
• Repayment of loans 
• Reimbursed business expenses
• Personal expense paid by business dollars

Wages Salaries, wages and or bonuses can be paid by a corporation to its owner(s) as a way of compensation.  This is a particularly good way to pay any owner(s) who actively works in the business.  There is no difference in treating these wages to shareholder owners from the corporation would to any other employee’s wages. The wages paid to the owners are deductible to the corporation.  These wages are subject to FICA and Medicare payroll taxes and ordinary income tax withholding with the payroll-related bureaucracy.  The matching portion of FICA tax due on these wages is also tax deductible to the corporation. These owner(s) will receive W-2 forms that show the total income paid to each owner for the entire tax year, as well as the federal income tax and FICA tax that was withheld from their total income.

Distribution of Profit The net earnings of the S corporation are passed through to the shareholders of the company. The share of profits is subject to federal taxes at the ordinary income tax rates but not FICA and Medicare taxes regardless distribution. Withdrawals in the form of distributions are tax-free and far more flexible (i.e. the company simply writes you a check). The movement of dollars from the corporation to its owner(s) is treated as the return of capital–creating no tax liability for either the business or its owners.

It is important that When the owner(s) withdrawal is  down to the points where more dollar is taken out than the owner’s basis of their respective accounts, they are taxed as capital gain.

Repay Loans The best way to make a loan arrangement is to prepare formal interest-bearing loan documents for any and all loan activity between a business and its owner(s) prior to any such dollar movement.  Be certain that the dollars repaid also include interest due; this interest will be taxable interest income to the payee(s).  If the repayment does not include an interest amount, the IRS will “Input” interest – which means that the payee(s) will owe tax due on input interest income.

The business owner(s) can put their own dollars into their business in form of loan.  Under the terms of loan agreement, once the owners loan dollars to the business (actually transferred into the business bank account), the business will be obligated to repay these dollars received (repayment of principal) plus interest due. The repayment of dollars loaned to the business by its owner(s) represents a repayment of “principal” and is therefore not income to the owner(s); and the interest received by the owner(s) is interest income and is a tax deductible expense to the business.

The IRS allows corporations to make loans to their owner(s). The business owner(s) have to repay loans made to them by the business. Don’t forget to add interest onto this debt repayment, and have the business show this interest as “interest income” – otherwise the IRS may input interest anyway and require the business to claim interest income it didn’t ever receive.

Business Expenses Reimbursement Reimburse yourself immediately for any and all business expenses you incur on behalf of your business. This creates an immediate tax deduction for your business and you don’t have to pay income tax for the reimbursement. You can best accomplish this reimbursement process by routinely submitting “Business Expense Reports” which summarize the business expenses you have incurred on behalf of the business. It is important to have an accountable reimbursement plan in place to avoid the reimbursement being counted as compensation.  Remember, these expenses require proper documentation in order to be fully tax deductible to the business.

Personal expenses out of your business checking account When you pay personal expenses from business dollars, this is precisely what a draw is from the company by the owner. The draws can be charged to an account called “Owner Draw” and closed to “Distributions” at the end of the year – or charged to the distribution account directly. However, the fact that these personal expenses ran through your business checking account may raise the level of IRS scrutiny.

It is always recommend that you consider either obtaining credit cards for your business, and/or using separate personal credit cards. This separation of business and personal credit purchases also makes any applicable interest and credit card fees on the “business only” credit cards fully tax deductible.