Uneven Shareholder Distributions, 1120S

[G2R]

1120S has four shareholders. All were also officers of the company. Reasonable compensation was paid to all four.

Three of the shareholders took it upon themselves to take large distributions in the previous year leaving one of the shareholders out.  I've let them know this violates the S-corp rules and puts the S-corp status in jeopardy. 

The company currently doesn't have any remaining cash to pay the 4th SH his distribution. Can they draft a loan agreement between the company and the SH, with proper interest, for the distribution that should have occurred?  

And if so, can the distribution be recorded at the time the loan is drafted? 

[Lee B]

 

There are a number of articles online about this issue, but this one should be helpful:

https://www.withum.com/resources/can-an-s-corporation-make-disproportionate-distributions/

[G2R]

1 hour ago, cbslee said:

 

There are a number of articles online about this issue, but this one should be helpful:

https://www.withum.com/resources/can-an-s-corporation-make-disproportionate-distributions/

What a great read.  Thank you @cbslee.  I appreciate it!  I found a number of articles regarding the uneven distribution discussions and definitely gained a tweak perspective on them. The loan idea came about for two reasons. 

1. The left out SH would earn something on the cash he wasn't given like the rest. 
2. The amount of time that uneven distributions existed would be shortened. 

That's why I'm hoping it's not a violation of any existing rules. So far, I haven't found anything that says it is. 

[BulldogTom]

2 hours ago, cbslee said:

 

There are a number of articles online about this issue, but this one should be helpful:

https://www.withum.com/resources/can-an-s-corporation-make-disproportionate-distributions/

That is a very good article.

Tom
Longview, TX

[ILLMAS]

What happens if the operating agreement allows for uneven distributions?

[DANRVAN]

30 minutes ago, ILLMAS said:

What happens if the operating agreement allows for uneven distributions?

Then the entity has a second class of stock and not eligible for S Corp status.

[DANRVAN]

6 hours ago, G2R said:

Can they draft a loan agreement between the company and the SH, with proper interest, for the distribution that should have occurred?  

And if so, can the distribution be recorded at the time the loan is drafted? 

Are you proposing a loan to shareholder # 4 and call it a distribution?  A loan to SH #4 would need to be repaid, so I don't see how it could be classified as a distribution.

[Lee B]

The article I referenced said that the uneven distribution could be made up in the following year even though that would be an uneven distribution.

"The regs do include a helpful example, however:

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"

I wouldn't create a loan document, I would just do a catch up distribution in the following year, nothing more should be needed

[DANRVAN]

4 hours ago, G2R said:

The loan idea came about for two reasons. 

1. The left out SH would earn something on the cash he wasn't given like the rest. 

Looks like I misunderstood.  So what you are proposing is a distribution payable by a note to shareholder #4? 

I don't believe you can call it a distribution until the shareholder is actually paid cash.

[BulldogTom]

OP says there is no cash to pay SH #4.   I think the other shareholders need to put some cash back in the company so it can be distributed to SH #4.   SH #1-3 can loan the company the cash (with a note, interest, payment schedule) to make the distribution to SH #4 if that is how they want to go about it, but SH #4 needs to be caught up quickly.

Tom
Longview, TX 

[G2R]

2 hours ago, BulldogTom said:

OP says there is no cash to pay SH #4.   I think the other shareholders need to put some cash back in the company so it can be distributed to SH #4.   SH #1-3 can loan the company the cash (with a note, interest, payment schedule) to make the distribution to SH #4 if that is how they want to go about it, but SH #4 needs to be caught up quickly.

Unfortunately this isn't going to happen.  Bitter infighting amongst the SHs.  Long, sad story. But thanks for the suggestion. 

16 hours ago, DANRVAN said:

Looks like I misunderstood.  So what you are proposing is a distribution payable by a note to shareholder #4? 

I don't believe you can call it a distribution until the shareholder is actually paid cash.

This is what I was hoping wasn't the case.  I didn't realize an actual cash transfer was a requirement.  Thank you for your insight @DANRVAN.