Typically, an owner of stock in an S corporation also performs services for the company making him, in addition to an investor in the company, an employee of the company.So what is the proper tax treatment of monies that are paid from business profits to the S corporation investor/employee?Creditors are always senior to shareholders in receiving the corporation's assets upon winding up.However, in case all debts to creditors have been fully satisfied, there is a surplus left to divide among equity-holders.When multiple properties are distributed, the corporation computes gain on an asset-by-asset basis (Rev. Gain attributable to capital assets and certain property used in a trade or business (Sec. Corporations generally report nonliquidating distributions to shareholders on Form 1099-DIV, Dividends and Distributions (Sec. has held his stock for three years, and his stock basis is ,000. The corporation cannot afford to redeem the stock entirely for cash because its cash balance of ,000 must be used primarily to service real estate debt. However, the shareholders agree that does not care which tract of land he receives in redemption of his stock because he plans to sell the land immediately. Unfortunately, a corporation cannot recognize a tax loss on a nonliquidating distribution of depreciated property (i.e., where the property’s FMV is less than the adjusted basis).
Assuming sufficient E&P, this would be a fully-taxable dividend.Tothe extent that a distribution by a corporation is not covered by currentor post-1913 earnings and profits, however, it is treated by§ 301(c)(2) as a return of capital to the shareholder, to be appliedagainst and in reduction of the adjusted basis of his stock.If thedistribution exceeds the adjusted basis of the stock, the excess isordinarily taxed as capital gain, with an exception of minor importancefor distributions out of increase in the value of corporate propertyaccrued before March 1, 1913.Under the Internal Revenue Code of 1954, the corporation is aseparate taxable entity, so that corporate income is taxed to thecorporation and dividends paid by the corporation are taxable to theshareholders.The framework for the taxation of corporate distributionsis provided by Sections 301 (a), 301 (c), and 316 of the Code.