LLC Taxed as an S-Corporation — Dividends (Capital Gains or Ordinary Income?)
Dividends can be classified as either ordinary income or capital gains, depending on the specific circumstances.
In general, dividends paid by most domestic and foreign corporations to individual investors are considered ordinary income for tax purposes. Ordinary dividends are typically subject to the ordinary income tax rates, which vary based on the individual’s income level.
However, certain dividends may qualify for a lower tax rate known as the qualified dividends rate. To qualify for this lower rate, dividends must meet specific criteria, including being paid by a U.S. corporation or a qualified foreign corporation and satisfying certain holding period requirements. Qualified dividends are taxed at the same rates as long-term capital gains, which are generally lower than ordinary income tax rates.
It is important to note that payouts of S Corporations are not considered to be “dividends” rather they are “distributions”. Primarily, S Corporations are only subject to one tax (not double tax as C Corporations are) and as we discuss as part of the training for our Limited Liabilities formations, the taxability of earnings from an S Corporation (or a LLC taxed as an S Corporation) is the same regardless of whether that income is actually distributed to the owner or not… Hence the normal distributions of cash is not taxable whatsoever to the owner of an S Corporation but as in all things, there are exceptions which are outside the scope of this blog.
It’s important to note that tax laws and regulations can change over time, so it’s always a good idea to consult with a tax professional or refer to the most recent tax guidelines to understand the specific tax treatment of dividends in your situation.
These are the types of questions we sometimes run into when forming LLC (Limited Liability Companies) for our clients. We look forward to serving you with your LLC formation and teaching consultation.