Pro rata liquidating distribution
Notice, however, that the example points out that the difference wasn’t the result of a “binding agreement relating to distribution or liquidation proceeds.” If the timing difference the result of a binding agreement, this would effectively be considered a difference in the shareholder’s rights, and the business would constructively be considered to have more than one class of stock and thus lose its S Corporation election.Several private letter rulings also give some examples where temporarily disproportionate distributions have been allowed.In a private letter ruling (PLR) issued back in May of 1995, an S Corporation had a “misunderstanding of the regulations” regarding S Corporations and had made disproportionate distributions to some shareholders over others.The S Corporation intended “…to make a distribution to its shareholders to equalize the cumulative amount of per share distributions, including interest, to correct for the distributions made…” during 1995.The restriction relates to how businesses can be qualified to be treated as an S Corporation in the first place.These rules are found in Internal Revenue Code Section 1361.Earlier this year, the IRS issued three private letter rulings benefiting S Corporations.
In short, yes, but only so long as corrective distributions are made afterwards, and so long as the disproportionate distributions are not made pursuant to any contract, shareholder agreement, or other binding document that would go so far as to suggest that shareholders have differing rights to any distributions from the S Corporation.
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.
Small business owners often wonder whether it’s acceptable to make disproportionate distributions to a shareholder of an S Corporation.
The following example paints a picture of a situation where business owners may consider this possibility: Tom and Jeff own an S Corporation called TJ Engineering as equal shareholders (i.e.