Q 1:

Subject: S corporation Shareholders

Kerry,  My question regards whether a S Corporation can have Inactive (authorized but not issued) shares.  A S corporation had 3 originals Shareholders but 2 of the Shareholders were bought out by the Corporation thereby leaving the remaining Shareholder with 100% Ownership and Control.  However, that shareholder has taken the Position that she is only a 45% owner (her original share percentage) and the remaining 55% are owned by the "Corporation".  I believe this position is in conflict with IRS rules regarding individuals reporting all income/losses thru their Personal Tax Returns.  Can you recommend any references that might clear this up.  I live in Louisiana but do not believe the Community Property Laws impact the question.  Any help will be GREATLY appreciated. 

A 1:

It is quite natural to have more authorized shares than are actually issued to owners.  In fact, I have long recommended that, when setting up a corporation, a much larger number of shares be requested so that there will always be some in reserve without the need to file additional papers with the Secretary of State's office.

For S corp purposes, only the outstanding shares count.  The unissued and treasury (bought-back) shares are completely irrelevant.  Thus, you are correct that the remaining shareholder now has a 100% share.  It is impossible for an S corporation to be its own shareholder.  In fact, corporations of any kind are legally barred from being owners of an S corp, or else the S corp election is automatically terminated.

This is such a basic matter that it points out the true underlying malady here - trying to run a business without the assistance of a professional tax advisor.  Your friend needs to hire the services of a competent tax advisor ASAP before she puts herself in serious tax and legal jeopardy.

Kerry Kerstetter

Q 2:

Thanks Kerry , Do you know of any Court Cases that deal with this issue?

A 2:

I don't know of any such cases.  In fact, I doubt if any exist because your friend's interpretation of ownership allocation is so wacky that I seriously doubt if anyone would take it all the way to court. 

The concept of basing S corp allocations on shares issued and outstanding is so cut and dried that no tax professional would be crazy enough to pursue your friend's theory and be laughed out of the court. 

The purpose of S corps is to pass through 100% of their net income or loss to the shareholders.  It makes no sense by any stretch of logic to think that 55% of the corp's income would stay with the corp itself and not be passed through just because that stock has been retired or repurchased by the corp.  The remaining shareholder now has an effective ownership of 100% of the corp and is required to report 100% of the corp's income on her 1040.  If the ownership change took place mid-year, there are a variety of methods by which to allocate the corp's net income between the old shareholders and the remaining one.

As I said earlier, this is why matters of tax law are not suitable for amateurs.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 6/18/2005 02:28:00 PM Send this post: