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Uneven Distribution of S-Corp Dividends

I have been in an S-Corp for several years with a partner. This year I wanted to get out of the corporation, or dislove the corporation. My (previous) partner refuses to dissolve, buy me out (even for nothing) and we are now going to court. In the mean time she removed over $120,000 from our joint company bank account. Prior to that she took over $80,000 in dividend distributions that I did not receive.

What are the tax laws with regard to this uneven distribution of dividends? I was under the impression that in an S-Corp all distributions had to be equal. (Or at least not this uneven)
Is she responsible for reporting these dividends on her taxes?

How do we handle the taxes for this S-Corp for 2006 filing?

Thanks for you adivce. I really have enjoyed reading your clear answers to others questions.

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S-Corp Dividends

You definitely have a problem.

The payment of dividends usually requires a vote by the corporations board of directors and/or the shareholders.

Dividends are paid per share. So if you each have an equal number of shares, you should each have received the same amount of dividends. By making unequal dividends your partner has effectively created two classes of stock. IRS regulations require that S-Corporations have only one class of stock, so this action by your partner could jeopardize the S status of your corporation.

If her payments are classified as dividends you must file Form 1099-DIV that reports the dividend payments to the IRS. Then she will have to report the dividends on her personal return. In addition, the dividend payments in general will show up on your corporation's 1120-S, though not to whom they were paid.

The distributions could be considered a return of capital. As long as her basis is greater than $200,000, it would probably be the best to classify these distributions as return of capital rather than dividends. Another option is to classify some or all of these payments as "Loans to Shareholders". Either of these would not be reported as income to your partner. It seems to me either of these classifications are more correct in that there was no vote to declare a dividend distribution and they would not put your S election at risk with the IRS. (Although it seems to me that any amount she took beyond her basis might be considered embezzlement. I'd check with your lawyer.)

Assuming the result of the court case is to dissolve the corporation, make sure these payments are included clearly on the financial statements of the corporation so they can be included in the calculation of the final liquidation.

You definitely have your hands full getting this all squared away. It will likely take you quite a bit of time and money. :(

Hope this helps.

Embezzel puzzel

Thanks so much for your response. What are the consequences to me if the corporations s-corp status is jeapordized... ? I think she deserves to have it ruined... but I may be hurting myself.

Losing S-Corp Status

A corporation's S election is terminated if it no longer meets the S-corp elibigility requirements, effective the date those requirements are no longer met.

Losing the S election would mean you would have to amend both your personal tax return as well as your corporation's. Depending on your business the corporation could be required to pay the 35% flat tax for Personal Service Corporations (PSCs). Also it would affect the state tax returns as well. Very messy.

Since I don't know exactly how the disbursements she made were classified I can't say for sure if the corporation did fail to meet the requirements.

Sorry you're stuck in this situation.:( I hope your court case goes well.


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