7.26.11

“S Corporation Shareholders and Disproportionate Distributions” by Tom Hager, CPA, CGMA, NSSA | Principal – Tax

What is a “disproportionate distribution?” A distribution made to a shareholder not in direct proportion to their stock ownership percentage.

This is a very important issue: FAILURE TO MAKE DISTRIBUTIONS IN PROPORTION TO OWNERSHIP PERCENTAGE CAN VOID THE S CORPORATION ELECTION.

Why is this? Because the IRS considers disproportionate distributions as evidence that the company has a second class of stock. Since an S corporation can only have one class of stock, disproportionate distributions can invalidate the S election.

If distributions have been made not in proportion to ownership percentages, immediate action to equalize must be taken. This is done by determining which shareholder received the highest distribution amount per share. All shareholders must be paid at this highest rate. The board of directors should authorize the equalizing of distributions, and the distributions should be paid as soon as possible.

Closely held S Corporations have a tendency to overlook the formalities of a corporate entity. Failure to do so could result in losing the tax advantages of the S corporation’s form of business.