Pro rata liquidating distribution
Tom and Jeff wonder whether they can make a cash distribution of 5,000 to Tom, but no distribution at all to Jeff, leaving the remaining retained earnings available to the business and thus satisfying the desires of both shareholders.
So based on this example, the question really is whether an S Corporation can make distributions to select shareholders that are disproportionate to the shareholders’ ownership interest.
S distributes ,000 to A in the current year, but does not distribute ,000 to B until one year later.
The standard procedure for the majority of S Corporations should be to make only distributions that are proportional to each shareholder’s ownership interest.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.We go from Section 1361 to the underlying treasury regulations, and we find the following explanation regarding this “one class of stock” rule: By reading this line, we should infer the general rule that distributions from S Corporations to shareholders should be proportional to each shareholder’s ownership interest.After all, if there is only one type of stock with “identical rights to distribution” proceeds, you cannot meet this rule by allowing a shareholder to have the rights to a higher ratio of the distributions than that shareholder’s ownership right would entitle him/her to. The regulations contain a few examples of when a disproportionate distribution would not harm the status of the business as an S Corporation.