Distributions made to shareholders during the corporation's operation, but not during its liquidation, are called nonliquidating distributions in an S Corporation. Cash or property can be part of these distributions but must follow specific tax rules.

• When the distribution doesn't exceed the shareholder's basis in the S Corporation stock, it's generally tax-free and decreases the shareholder's basis in the stock.
• In the event that the distribution exceeds the shareholder's basis, it is considered a capital gain and is taxable.
• If the S Corporation has accumulated earnings and profits (E&P) from its previous status as a C Corporation, a portion of the distribution may be taxed as a dividend.
• The amount of distribution is determined by the fair market value (FMV) of the property when it is distributed. In the event that the FMV exceeds the property's adjusted basis, the corporation may recognize a gain and pass it on to the shareholders.

Let me explain the non-liquidating distribution with an example.

1. "W" is a shareholder of the "T-Corporation", a calendar-year S Corporation.
2. "T" is indebted to "W" in the amount of $5,000.
3. "T-Corporation" earned $25,000 of ordinary income and distributed $10,000 as a dividend to "W".
4. How much income should "W" report from "T-Corporation" for the current year?

The shareholder W must pay taxes on the entire earning and profits regardless of the amount of profit distributed by corporation T. The non-liquidating distribution in this example is $25,000 instead of just $10,000. If it were a 'C-Corporation', a shareholder would only have to pay taxes on $10,000, not their entire income.