We are an S Corporation with a fiscal year end of September 30th. Is there a way that the existing S Corporation shareholders can take distributions to pay the estimated income taxes, and the new shareholders would not take distributions until next year? Can this be done without breaking the S election?
In short, its possible to have a timing issue with distributions and not have the S corp lose its tax status.
The issue is whether or not the fact pattern causes the S corporation to be considered to have multiple shares of stock and thus lose the election. As long as the shareholders all have the same distribution and liquidation rights, there shouldn’t be an issue as per IRC Section 1361. Moreover, the regulations provide that the determination of whether all outstanding shares of stock confer identical rights to distribution and liquidation proceeds is made based on the corporate charter, articles of incorporation, bylaws, applicable state law, and binding agreements relating to distribution and liquidation. This means that 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 right to the distribution, despite the fact that a distribution happened to be made disproportionately.
This is further supported in PLR 201426009 and detailed in the below example
“S, a corporation, has two equal shareholders, A and B. Under S’s bylaws. A and B are entitled to equal distributions. S distributes $50,000 to A in the current year, but does not distribute $50,000 to B until one year later. The circumstances indicate that the difference in timing did not occur by reason of a binding agreement relating to distribution or liquidation proceeds. Under paragraph (l)(2)(i) of this section, the difference in timing of the distributions to A and B does not cause S to be treated as having more than one class of stock.”
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IRC Section 1361 & PLR 201426009