Are Equal Distributions Required In An S-Corporation?

S-Corporations are some of the most common corporate entities that are used in business, particularly because of its pass-through taxation benefits and the protection it offers to shareholders. However, maintaining an S-Corporation can be challenging if the standards required by the Internal Revenue Service (IRS) are not met. 

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, 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.

Shareholder Distributions

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.

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 Distributions Be Unequal?

The answer depends on what is meant by unequal distributions. If unequal means not equal to each other, 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 LLC that elected to be an S-Corporation, each shareholder will receive distributions according to their respective percentage holding of stock in the corporation.

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