Reclassify Shareholder Distributions

By Jason Watson, CPA
Posted Friday, November 3, 2023

Since payroll might be late to the S Corp party during the first year, at times we need to re-classify prior shareholder distributions as shareholder wages (and perhaps employee reimbursements).

Here is a sample journal entry for an S Corp shareholder who took out $20,000 as a shareholder distribution, but later reclassified the transaction as shareholder distributions, wages and employee reimbursements.

	DR	CR
Shareholder Distributions		8,950
Shareholder Wage Expense	7,000
Employee Reimbursements	1,950
Totals	8,950	8,950

When the original distribution took place, there was a debit to Shareholder Distributions for $20,000 and a credit to Cash for the same. We are simply reducing the $20,000 by $8,950 so the actual distribution reflects $20,000 less $8,950 or $11,050.

In other words, Shareholder Distributions was a negative $20,000 in the equity section of your business’s balance sheet. After increasing Shareholder Wage Expense by $7,000 and Employee Reimbursements by $1,950, net ordinary business income is reduced by $8,950. This naturally reduces equity by the same amount therefore Shareholder Distributions must be reduced so equity remains unchanged. No adjustment is made to Cash. Make sense? Don’t worry… we can provide these journal entries as necessary. We are just geeking out on our own silly accounting fun.

If we were putting this transaction into the books together from the start, it would look this starting with the shareholder distribution-

	DR	CR
Shareholder Distributions	11,050
Cash		11,050
Totals	11,050	11,050

Then the Shareholder Wage Expense and Employee Reimbursements-

	DR	CR
Shareholder Wage Expense	7,000
Employee Reimbursements	1,950
Cash		8,950
Totals	8,950	8,950

Everything would end up in the same spot- Shareholder Distributions at $11,050, Owner Wage Expense at $7,000 and Employee Reimbursements at $1,950. Cash spent would be $20,000. The only difference is the first example is a correcting or reversing entry.

This sample is a slight over-simplification since there would also be a Payroll Tax Expense entry for the business’s portion of Social Security, Medicare, Unemployment, etc. but you get the idea.