Who Pays S Corporation Dividends?

by Terry Masters
Shareholders are entitled to share in corporate profits.

Shareholders are entitled to share in corporate profits.

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Shareholders of a corporation are entitled to a share of the corporation's profits. The way profit distributions are classified and handled depends on the way the corporation pays taxes. An S corporation's special tax status requires it to allocate profits to shareholders every year, but does not require the corporation to distribute the profits. Decisions regarding whether to distribute profits or hold onto the money as working capital are made based on state law.


An S corporation starts out as a regular corporation, also known as a C corporation in reference to the chapter of the Internal Revenue Code under which it is taxed. If a corporation meets certain special requirements, it can make a tax election to be taxed under subchapter S of the IRC instead of subchapter C. A subchapter S corporation is taxed as a disregarded entity and does not have to pay corporate-level taxes. Instead, the corporation passes its profits and losses through to its shareholders to be taxed at an individual tax rate.


Technically, dividends are paid by C corporations out of after-tax profit. Once a C corporation calculates net income and pays corporate taxes on the amount, the remainder is considered profits and placed in the corporation's retained earnings account. Dividends are distributed to shareholders out of retained earnings and taxed again on the individual shareholder's tax return. This double taxation of corporate profit distributions is avoided by the S corporation since it is not taxed at the entity level. An S corporation does not have retained earnings in the traditional sense and does not distribute dividends, since dividends are paid out of after-tax profits and the S corporation does not pay taxes.


Instead, an S corporation makes distributions of profits to shareholders. As a disregarded entity, an S corporation must allocate profits and losses to shareholders every year so the amounts can be taxed at the individual level. These amounts must be allocated every year for tax purposes, but the S corporation is not required to actually distribute the profits. S corporation shareholders can end up paying taxes on profits in a year when they do not necessarily receive those profits in hand. The only way an S corporation would have traditional dividends to pay out is if it has a leftover retained earnings account from when it was taxed as a C corporation, before it made the subchapter S election.

Distribution Decisions

Whether an S corporation calls shareholder payments distributions or imprecisely calls them dividends, the decision regarding whether to pay out profits to shareholders is made by the board of directors. Under state law, the board of directors is responsible for the day-to-day management of a corporation. Shareholders get to vote on the membership of the board, but once the directors are elected, a shareholder's influence ends. S corporations often have shareholders who hold enough shares to elect themselves to the board. In this instance, a shareholder-director will have a say in setting the schedule of profit distributions.

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