S Corporation Dividends and Taxation
Qualified dividends: In certain cases, S corp dividends may qualify for lower tax rates. To be classified as qualified dividends, the dividends must meet specific criteria set by the Internal Revenue Service (IRS), including various holding period requirements.
S corporations distribute their earnings among their owners, also known as shareholders. C corporations are traditional companies that pay dividends to their shareholders. C corporation dividends are taxable. S-corporations are pass-through entities. That is, the corporation itself is not subject to federal income tax. Instead, the shareholders are taxed upon their allocated share of the income.
S Corporation Distribution Taxation
S corporations generally make non-dividend distributions, which are tax-free, provided the distribution does not exceed the shareholder’s stock basis. Under current tax law, the dividend is taxed at a preferential qualified dividends rate, which is 15% or less in most cases. Distributions of previously taxed income from an S-Corporation are not subject to income tax if you have the basis in your stock to cover them. However, they should not be taken before the S-Corporation has paid you reasonable wages (subject to FICA and Medicare Tax) for your services.
Qualified Dividends Regulations
Qualified dividends must meet special requirements issued by the IRS. The maximum tax rate for qualified dividends is 20%, with a few exceptions for real estate, art, or small business stock. Non-qualified dividends are taxed at income tax rates, which as of the 2023 tax year, maxes out at 37%. ETFs may or may not pay qualified dividends. Receiving the dividend in cash rather than reinvesting it can cause a dividend to be non-qualified. Shareholders prefer qualified dividends over non-qualified due to more favorable tax rates.
Taxation of S Corporation Distributions
S-Corps are subject to single taxation. Income earned is distributed among shareholders. Excess distributions exceed shareholder’s stock basis and are taxed as long-term capital gains. Profits and losses flow to shareholders’ personal tax returns.
S Corporation vs. C Corporation Taxation
S corps have the advantage over C corps of no corporate income tax. Shareholder distributions are only taxed individually.