Taking Shareholder Distributions
By Jason Watson, CPA
Posted Sunday, October 10, 2021
The IRS and Tax Court do not like to see you use your business as an ATM machine. This is not because you just said automated teller machine machine. This is because the spirit of a shareholder distribution is to be a return on investment, and if it is magically tied to personal living expenses it looks bad. Think of it this way- you wouldn’t call up Google and demand a dividend because baby needs new shoes, or the boat payment is due. Same thing here.
Another perspective- Apple shareholders are routinely upset because of the cash that Apple hoards. There are two ways to get a return on investment- capital appreciation (and subsequent sale) and dividends. If there are piles of cash and there aren’t immediate or mid-term needs for the cash, shouldn’t that be returned to investors who helped build the cash to begin with?
What do you do? One option is to take systematic shareholder distributions throughout the year, and flush out the remainder once a quarter or annually. Another option is simply distribute large chunks periodically without any cadence or basis that can be tied to personal living expenses. WCG prefers the first option. Looks clean. Defensible.
Sidebar: Lenders do not like to see a bunch of cash in your S corporation bank account. If you are looking to buy a house in the next six months, drain your business bank account down to the operational minimum. Lenders see $100,000 in the business account and they assume the business needs this. You roll up and say you are going to take it all out for a down payment. Now the sales prevention team (i.e., underwriting) thinks your business will suddenly fail which cuts off your ability to service your debt. Next thing you know we have to write letters explaining that your business won’t fail because of this cash drain and it becomes a big headache for everyone.
Here is another consideration. If you pile up money for a handful of years, and then flush it all out in one year, the relationship between income, reasonable shareholder salary and distributions will be unbalanced. Keep in mind that one of the criteria the IRS and the Tax Court uses to test the reasonableness of a shareholder salary is the comparison between salaries and distributions. You don’t get rollover credits for all those years where you didn’t take out distributions, and while you can demonstrate the problem in support of your salary why have the conversation at all?
Bottomline- do not leave cash laying around in your business. Earmark it for future short-term purchase, put that money to use immediately, or put it in your personal savings account or retirement fund. Business owners routinely use their business checking account as a personal savings account. Bad. Don’t do it. Run your business like a business, and make sure retained cash has a purpose! Idle business cash has very little upside unless you have a capital expenditure or some other near-future use.
A common question that is asked is “If I take too much out, can I return some of the shareholder distribution back to the business?” Yes, you can. This is very common actually. Not elegant or ideal, but common. Things happen. No, this is a shareholder loan or additional paid in capital. It is a return of excess distributions. Keep it simple.
Taxpayer's Comprehensive Guide to LLCs and S Corps 2021-2022 Edition
This KB article is an excerpt from our 430-page book (some picture pages, but no scatch and sniff) which is available in paperback from Amazon, as an eBook for Kindle and as a PDF from ClickBank. We used to publish with iTunes and Nook, but keeping up with two different formats was brutal. You can cruise through these KB articles online, click on the fancy buttons below or visit our webpage which provides more information at-