An S corporation offers limited liability protection, and avoids the double taxation issues presented by C corporations. However, there are some disadvantages for S corporations, such only being allowed to issue one class of stock. This means that all distributions must be the same across all the shares of stock. This makes the calculations very simple, but it presents problems for S corporations that would prefer to issue non-cash distributions, or for those that want to account for sweat equity.
Determine the total amount of cash that is available for distribution. This is whatever the corporation has that can't be profitably reinvested in the business at above-market rates, is not needed to fund operations, pay accounts receivable or to fund planned acquisitions.
Determine the total number of outstanding shares. The corporation's founding documents, including the articles of incorporation, should include the total number of shares. These shares may be distributed among up to 100 shareholders, which is the limit for an S corporation.
Divide the amount available for distribution by the total number of shares outstanding. This is the pro rata distribution per share. Each share must receive an equal distribution, per S corporation rules.
- If you have shareholders who want to build up equity in the business through their labor or expertise, you might consider forming a C corporation, limited liability company (LLC), or limited partnership, which grants more flexibility to crediting the equity accounts of sweat equity shareholders and passive investors.
- If the IRS learns you distributed profits to shareholders unevenly, you could find your status as a C corporation disallowed. This means your corporation will no longer be treated as a pass-through entity, but be subject to corporate income tax of up to 35 percent, as of 2011.
- stocks and shares image by Andrew Brown from Fotolia.com