Variations of the following question commonly make their way into Copy Taxation HQ, by which I mean my email:. My customer is an S corporation owned equally by A and B. This is a commonly misunderstood area of tax law. In short, S corporations have more flexibility than you realize to make distributions that are not perfectly pro-rata to its shareholders.
The genesis of the jumble is found in Section b 1 D , which provides that in order for a corporation to be eligible to make an S election, the corporation can only have identical class of stock outstanding.
"Burlington" Transfers of property to shareholders for less than FMV. In preparation for the retirement of the five major shareholders, corporation R, in a single and isolated transaction, has a recapitalization in which each share of class A stock may be exchanged either for five shares of new class B nonconvertible preferred stock plus 0. Thus, during the second year, the conversion ratio would be 1.
If, however, a dividend were declared upon the class A stock payable in a new class of preferred stock that is subordinated in all respects to the class B stock, the distribution would not increase the proportionate interests of the class A shareholders in the assets or earnings and profits of the corporation and would not be treated as a distribution to which section applies.
Cornell Law School Search Cornell. Since in computing the amount of additional shares deemed to be distributed to F and H the redemption of shares is disregarded, the redemption of shares will be similarly disregarded in determining the value of the stock of the corporation which is deemed to be distributed.
"Burlington" The conversion ratio of the class B stock is increased in to reflect the three stock dividends paid on the class A stock. If the election is made within such period, and, if the income tax return has been filed before the time of such election , the statement of adjustment and the description of the antidilution provisions required by subparagraph 2 iii shall be filed with the Internal Revenue Service Center with which the income tax return was filed.
Since the class A shareholders as a class have an increased interest in the assets and earnings and profits of the corporation, the stock distribution is treated as a distribution to which section applies. If, however, the conversion ratio of the class B stock were subject to full adjustment to reflect the distribution of stock to class A shareholders, the distribution of stock dividends on the class A stock would not increase the proportionate interest of the class A shareholders in the assets and earnings and profits of the corporation and such distribution would not be a distribution to which section applies.
The items in this blog are informational only and are not meant as tax advice. File Form if the corporation pays dividends that are not taxable.
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- DISPROPORTIONATE DISTRIBUTIONS DO NOT ALWAYS ENDANGER S CORPORATION STATUS
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