Disproportionate liquidating distributions
The primary difference between C corporations and S corporations is that C corporations are taxed twice on earned income: : once at the corporate level when the income is earned, and again at the shareholder level when the income is distributed.The rules governing distributions from C corporations differ from the rules that apply to distributions from S corporations.Furthermore and for the sake of conservatism, it’s best if S Corporations avoid disproportionate distributions where possible.The standard procedure for the majority of S Corporations should be to make only distributions that are proportional to each shareholder’s ownership interest.After determining under the facts that there was only one class of stock in this particular S Corporation, the ruling was that the business under the circumstances should not lose its S Corporation election.In another PLR issued on the same day, another S Corporation had made disproportionate distributions to shareholders in order to help the shareholders satisfy their tax liability incurred from the income generated by the S Corporation itself.So going back to our initial example, may we conclude that TJ Engineering may make the disproportionate distributions to satisfy the desires of both shareholders?
Several private letter rulings also give some examples where temporarily disproportionate distributions have been allowed.
The overall lesson to be learned through all this is fairly simple: disproportionate distributions should be avoided, but having them for a time will not necessarily result in termination of the S Corporation’s election, so long as they’re not permanent.
Differences in distributions for the sake of facilitating necessary payments to some shareholders and timing differences for other legitimate purposes won’t ruin the election, but every caution should be taken to make sure that, in the end, any disproportionate distributions are later corrected with equalizing distributions.
When Tom finds himself in hard times financially, he wants to have TJ Engineering make distributions to help him get by.
Jeff, on the other hand, doesn’t need the cash and would rather leave the money available to the business to help finance construction of a new office building.
So going back to our example, does this mean that if Tom and Jeff were to execute their plan, the business’ S Corporation election would be terminated? The first of these examples goes as follows: S, a corporation, has two equal shareholders, A and B.