LYCOS RETRIEVER 
S Corporation: Amounts
built 283 days ago
For S Corporations with no earnings and profits, distributions are applied against basis of the shareholder’s stock. If the distribution exceeds the adjusted basis of the stock, the amount in excess is treated as gain from the sale or exchange of property. Sec. 1368. Distributions
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Using something like a 60-40 approach is better than nothing, in that it should prevent the S corporation from paying no salary to the SE and ... triggering an audit. But keep in mind that the base for any percentage approach is likely to change dramatically from year to year, thus creating wide salary disparities. For example, suppose Jorge is an SE who takes $50,000 in distributions from his S corporation in year 1 and $80,000 in year 2. In both years he devotes the same amount of time to the corporation. Is a year 1 reasonable salary 60/40 X $50,000 = $75,000 and a year 2 reasonable salary 60/40 X $80,000 = $120,000? Of course not.
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Previously, under the 12-month liquidation provision, a corporation could sell its assets without recognizing gain at the corporate level and distribute the proceeds to its shareholders. The act ... required a C corporation that distributed appreciated property to shareholders to be treated as having sold the property to them at an amount equal to fair market value. Both types of distributions continued to be subject to tax at the shareholder level.
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The reclassification of a distribution to salary decreases the S corporation’s bottom-line income by an amount roughly equal to the salary, but it does not result in a dollar-for-dollar tradeoff of tax liability. As shown in the following example, the government collects more taxes when the payment is made as salary. (See ... James Fellows and John Jewell, “S Corporations and Salary Payments to Shareholders,” The CPA Journal, May 2006, pages 46–51, for a more extended discussion of this point.)
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