llions of corporations have found S corporation status to be beneficial for both federal and state income tax purposes.When a corporation makes an election to be taxed as an S corporation, its shareholders generally are taxed on their allocable shares of income and may—subject to limitations—deduct their allocable shares of the corporation’s losses.Stated in a more simple manner, a disproportionate distribution will not be treated as creating a second class of stock, provided the underlying stock provides both A and B with identical to the distribution, despite the fact that a distribution happened to be made disproportionately.That being said, in order to avoid jeopardizing its S election, the corporation would be well advised to make a corrective distribution (even though that distribution will also be disproportionate) as soon as possible.The shareholder’s basis is decreased (but not below zero) by the shareholder’s share of the S corporation’s items of loss and deduction, nondeductible expenses (except expenses that are not chargeable to the capital account), depletion deduction for oil and gas property, and distributions to the shareholder that are not made from accumulated earnings and profits.This helps ensure that the shareholder only benefits once from reductions in income earned by the S corporation.This article examines some of the issues corporations commonly encounter in complying with the built-in gains tax.
Because the tax consequences of distributions depend on the shareholder’s basis, it is important to keep up with changes in the shareholder’s basis over time.
A shareholder’s basis in his S corporation stock is increased by the share of the S corporation income that is passed through to the shareholder.
This effectively gives the shareholder a credit to apply against the earned income when it is ultimately distributed to the shareholder, ensuring that the income is only taxed once.
So how tolerant is Congress and the IRS when a disproportionate distribution is made but the underlying stock confers identical rights upon the shareholders? S distributes ,000 to A in the current year, but does not distribute ,000 to B until one year later.
The language of the regulations provides little comfort, stating merely, “Although a corporation is not treated as having more than one class of stock so long as the governing provisions provide for identical distribution and liquidation rights, any distributions (including actual, constructive, or deemed distributions) that differ in timing or amount are to be given appropriate tax effect in accordance with the facts and circumstances.” The regs do include a helpful example, however: S, a corporation, has two equal shareholders, A and B. The circumstances indicate that the difference in timing did not occur by reason of a binding agreement relating to distribution or liquidation proceeds.