S-Corporation Distributions

[Wendy]

I've been asked to do new 1120S, which was set up by the owner and they did all the bookkeeping. Don't you just hate those? Now I'm getting myself confused.

Two shareholders contributed about 3000 each.

NO stock issued - 1000 shs allowed

Took salaries - no problem there

Net profit about 1800

Then they issued themselves checks classed as "withdrawals" for another 19000

Are they truly shareholders with no stock?

Distributions of profit in excess of basis is capital gains, but in excess of PROFITS? Shareholder loan?

Thanks

Wendy

[JohnH]

They need to re-check their organizational minutes.

(If they don't have organizational minutes they need to get busy drawing some up)

If they never issued stock, then the corporation never was perfected.

But consider this - when they filed the 2553 to obtain S-corp status, they had to state the number of shares owned by each shareholder and when the shares were issued.

[Jake]

Are the withdrawls misclassified as an expense item on the P&L? I see that on occasion with clients that "do their own bookeeping". If not, the cash for the distributions had to come from somewhere probably loans that may or may not be added to s/h basis. Sounds like a fun one to handle during the off season.

Good Luck

[kcjenkins]

Yes, clearly, you are going to have to look at their bookkeeping, to see where that money came from. Either they borrowed a lot of money for the business, then took it out for personal use, or that 'profit' was the amount left AFTER the distribution of profits to themselves. Clear that up, and you will probably know what to do. If not, post again with what you learned.

[joelgilb]

As an attorney I am going to give you the legal (not tax) answer.

When a corporation is created in any State, it has to indicate the number of shares authorized and the number issued to its shareholders, as well as the dollar amounts. Then for a shareholder to be a shareholder they MUST have stock issued in their name, by creating a "Stock Certificate" which lists the number of shares issued to them. Far to often the stock certificates are never created or created after the fact to reflect the history, so get them or their attorney to prepare certificates now.

They also are required by State laws to have a Corporate Book, Minutes and Bylaws to be legally incorporated and in most States they need to record the Articles with the local county as well. Note that you should not create these documents as it is practicing law without a license and is a crime in most States.

So how do you get this information? Ask your client for a copy of the Articles, or possibly get one from the Secretary of State as some States have them available online. The Articles will let you know how many shares were issued and the dollar amounts (although not necessarily to whom issued).

John is also right that you could look at the 2553 and see how many shares are shown for each, however, I have found that if 2 different professionals did the work or the client directly that the 2553 does not always agree with the actual Articles. Which of course creates additional problems which will need to be corrected.