S-Corporations are some of the most common corporate entities that are used in the state of Florida, particularly because of its pass-through taxation benefits and the protection it offers to shareholders. This is one of the benefits that attracts many to the corporate entity in Florida, particularly Miami as a center of growing new businesses. However, maintaining an S-Corporation can be challenging if the standards required by the Internal Revenue Service (IRS) are not met.
What is an S-Corporation?
A corporation or business entity such as a Limited Liability Company (LLC) can elect to be treated as an S-Corporation for tax purposes with the IRS, however, it must be a domestic corporation, such as an LLC organized in Florida, have allowable domestic shareholders, have no more than 100 shareholders, have only one class of stock, and not be an ineligible corporation. An S-Corporation elects to pass corporate income, losses, deductions, and credits through to the shareholders for U.S. federal tax purposes. The shareholders then report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates, rather than the corporate tax rate. As Florida is a state that does not have state income tax, this makes the election of an S-Corporation far more lucrative as individuals only pay income tax on the pass-through earnings at the federal level, not the state level.
What is a Shareholder Distribution?
A shareholder distribution in an S-Corporation are the earnings by the S-Corporation that are paid out as dividends to the shareholders of the corporation and are only taxed at the shareholder level. This is what is known as “passing through” the corporations’ earnings as personal income to the shareholders to avoid double taxation. This is great for shareholders living in states like Florida that do not have state income taxes. It allows for shareholders to receive their distributions and only have to pay federal income tax on them at the individual rate rather than the corporate rate. The distribution is based on the percentage of stock that each shareholder holds in the corporation. Because S-Corporations may only issue one kind of stock the distribution of the earnings to shareholders should always be proportionate to their holdings in the corporation.
Can Shareholders Have Unequal Distributions?
The answer depends on what is meant by unequal distributions. If unequal means not equal to each other shareholders, that may be acceptable if there are more than two shareholders with varying percentages of the corporation as stock. For example, if there are three shareholders with increasing holdings of 50%, 30%, and 20% of a Florida LLC that elected to be an S-Corporation, each shareholder will receive distributions according to their respective percentage holding of stock in the corporation. However, if unequal means that the one of the three shareholders in the above example did not receive their 50%, 30%, or 20% respectively in distributions.
What happens if an S-Corporation provides Disproportionate Distributions?
In short, the IRS can reassess the corporation and revoke the S-Corporation election. Unequal distributions that are not proportionate to the percentage that a shareholder holds in the corporation is not allowed under the tax code and can lead to the reclassification of the corporation, which can also be done if proper salaries are not paid out by the corporation.