Distributions from Partnerships and S-Corps

On several occasions, the following scenario has played itself out in my office: client comes in very excited, exclaiming that they are "going out on their own".  We file all the necessary paperwork to get an employer identification number, articles of incorporation, and have a quick run-through of how to keep up with income and expenses.  Then, they are on their merry way.

About a month later, the client calls and asks "how do I pay myself?"  

This is a common issue for small business owners, especially when they are set up in partnerships or S-Corps.  To begin, partners in partnerships typically do not draw salaries, and S-Corp shareholders only draw "reasonable compensation" during the year.  The remainder is taken by the partner/shareholder as a distribution, loosely defined as taking cash out of the business.  

Here is an example.  Jim is the 100% shareholder of Jim's Tools Inc, an S-Corp.  For the year, Jim has taxable profit of $100,000.  Of that, he pays himself a salary of $30,000, leaving the company with a $70,000 profit.  Jim will pay taxes on both his $30,000 paycheck and the $70,000 profit of the business on his personal return.  Assuming he is in the 25% tax bracket, his tax burden will be $25,000 ($30,000 paycheck + $70,000 business profit x 25% tax rate).  Based on these facts, he is permitted to distribute up to $70,000 of cash from the business to himself.  At the end of the day, he is left with $75,000 in his personal bank account after paying taxes.  

Partnerships work in a similar way, minus the salary.  The big difference is that the income from a partnership is likely to be subject to self-employment tax, since there is no salary involved.  In an S-corp, the shareholder will pay self-employment tax (payroll taxes of FICA and Medicare) on their paycheck.  Since a partnership does not pay a salary to the partner, the partner is responsible for this on their personal return.  But, distributions work the same way: if a partner has net profit for the year of $100,000, they will pay ordinary and self-employment tax on that money, but will be permitted a distribution up to $100,000.  

The main thing to remember is that S-Corps must pay a reasonable salary during the year to its shareholders, which is the tradeoff for the net earnings from the S-Corp not being subject to self-employment tax.  Partnerships and S-Corps should also keep track of their distributions during the year for reporting on the tax return at the end of the year.  

New tax due dates

At the end of July, Congress passed the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015.  This bill includes several provisions related to the Highway Trust Fund, road improvements, and health care for veterans.  But, it also included changes to tax return due dates which will take effect for tax years beginning after December 31, 2015.  

Background

Prior to the passage of this law, tax return due dates followed a schedule we have all been familiar with for many years.  For calendar year taxpayers, the due dates were March 15 for corporations (C and S) and April 15 for partnerships, individuals, and trusts.  Corporations, partnerships and trusts got an extension to September 15, and individuals to October 15.  Also, calendar year benefit plans (Form 5500) were due July 31 with an extension to October 15, and annual reports of foreign bank accounts (Form 114) were due June 30 with no extension.

For years, the AICPA and other tax advocacy groups pushed to change the deadlines of corporations and partnerships.  Corporations claimed March 15 was too soon to complete their return, especially large corporations that filed in several states.  Individuals would also find themselves in a bind if they received a K-1 from a partnership at 5pm on April 15th, not giving them enough time to complete their 1040.  The new dates are designed to alleviate some of these time constraints.  

New due dates

For tax years beginning after December 31, 2015 (2016 tax year, filed in 2017), the new due dates are as follows: S-corporations and partnerships are due March 15, and C-corporations, individuals, and trusts are due April 15.  Partnerships and S-corps, will get an extension to September 15, while C-corps and individuals get until October 15 on extension.  Trusts on extension will get until September 30.  Form 5500 will still be due July 31, but will get an extension until November 15.  Finally, Form 114 will now be due on April 15 with an available 6 month extension to October 15.  

Practical application

There are a few benefits to the new deadline structure.  For large partnerships with several unrelated partners, potentially having a K-1 in March as opposed to April will allow individual taxpayers to file on time when they might not have been able to before.  And, for large C-corporations, the added month to close out the year and finalize the tax return will reduce some of the pressure to complete the return, especially if there are many states involved.  The true burden will be placed on the tax preparer, who will have to juggle the new deadlines for partnership and C-corporations.  

Keep in mind there is nothing stopping partnerships and S-corps from requesting an automatic extension on March 15 and completing the returns under the same timeframe as in the past.  By doing this, the time burden will ultimately stay with the individual to complete their return by the due date once their K-1 is received.  The hope is that everyone will abide by the new deadlines as best as possible, and the Treasury can count on the majority of their tax revenue coming on April 15 of each year.