Financial Statement Review and Ratio Analysis(#2 in series)
Q: Don’t owners have to pay taxes on the portion of the distribution that was above and beyond their net income for Subchapter S corporations? Because isn’t it assumed that they are using distributions to pay taxes? Or can they just take out as much as they want?
A: Distributions made by any non-Subchapter C business entity – a Subchapter S corporation, partnership, LLC, or sole proprietorship – to its owners, partners, or members are not taxed unless they exceed that person’s basis in the company. In this context, an individual’s basis is roughly his or her capital contributions, plus that person’s share of profits over time, minus distributions.
An owner’s basis in a Subchapter S corporation is increased by loans to the company from the owner because they are considered to be quasi-equity. A partner’s basis in a partnership is increased by his or her share of partnership liabilities for which he or she is responsible. The accountant would make a calculation each year to determine an owner’s basis in the company, and if distributions exceed the individual’s basis and are, therefore, made subject to taxation, the long-term capital gains rate usually applies.
The underlying rationale is that the owner has recovered his or her entire investment in the company and the excess is considered a return on investment.
Q: What would be an example of non- cash charges other than amortization and depreciation?
A: Examples of other non-cash charges would be such events as a bad debt expense, an unrealized loss on a financial investment, or a write-down of stale inventory if the market value of inventory falls below historical cost.
Q: How did you come up with the 2013 Net Profit before Tax of $181,530?
A: Total Coverage, Inc.’s 2013 Net Profit after Tax was $179,349. This amount includes a $2,181 payment to the Franchise Tax Board, with is the income tax agency in the State of California. Therefore, Total Coverage, Inc.'s pretax profit in 2013 was $179,349 + $2,181 = $181,530. Larry Crevin has to pay taxes on the pre-tax amount.