S Corporation Income Split: How to Handle Allocations with Multiple Partners.

Let's start by exploring how S Corporation handle different income splits when there are multiple partners involved.

When you have an S Corporation, you must allocate and distribute profits to shareholders based on their ownership percentage. For example, if you and your partner each own 50% of the S Corporation, all distributions must also be 50-50, regardless of individual contributions or production levels. Did you work while your partner went on an exotic vacation? It does not matter! You will still receive only 50% of the income.

However, if your entity was a partnership and not an S Corp, you could choose to allocate profits differently from ownership shares. In a partnership, you and your partner can split income based on how much each of you worked and earned, rather than equally.

Balancing the S Corporation Income Split

If you want to adjust the S Corporation income split but remain an S Corporation, one possible solution is to adjust salaries. For instance, if you and your partner are 50-50 owners but want to reflect a 55-45 income split, you can increase the salary of the partner who should receive 55% of the income. Keep in mind that higher salaries lead to higher payroll taxes. For every additional $10,000 in salary, expect to pay about $1,500 in payroll taxes.

Alternative Solutions to Balance the S Corporation Income Split

To avoid higher payroll taxes while balancing the S Corporation income split, some business owners choose a workaround by establishing a holding company. In this structure, each S Corporation is a member, and each is fully owned by its respective business owner. The holding company collects the revenue and allocates it to the S Corporations based on the work performed. Common expenses (such as professional fees, rent, and software) are paid by the holding company and split among the partners.

Each S Corporation then determines reasonable compensation for its owner, handles its expenses (like cars and business use of the home), and may even earn additional income separate from the holding company. At tax time, the holding company issues K-1s to each S Corporation, showing their share of net income, and each S Corporation issues K-1s to its owners, reflecting their respective net income and expenses.

Second Alternative Solution

Another option for managing the S Corporation income split is to create a holding company owned directly by the individual partners. In this structure, income flows to the partnership, and the S Corporations issue invoices for their professional services, deducting common expenses. The partnership then pays these invoices, reducing its income to zero or a nominal amount. As a result, each individual receives two K-1s—one from the partnership and another from their respective S Corporation.

This strategy allows for more flexibility, as each partner can manage their own business expenses independently. Partners can also enjoy the benefit of reasonable compensation, maintaining the primary advantage of S Corporations.

Key Considerations

It's important to note that in these scenarios, S Corporation income split arrangements should not involve issuing 1099 forms, as S Corps are considered corporations for tax purposes. Furthermore, 401(k) plans in this situation can be complex due to controlled groups.

We hope this gives you a better understanding of how the S Corporation income split works and the various options available for balancing income among multiple partners. If you need help with tax planning and accounting services, our CPA firm specializes in helping S Corp owners navigate these complexities.

For more details, check out our services here.