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Ask a Lawyer -- Corporations
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Question: My husband has owned 10% of a Sub-S Corporation in Indiana for 9 years. He has never received a dividend check, only a check to pay federal taxes. The corporation keeps his share of the profits every year. ($28,000 for 2004) If this is legal, why would anyone invest in a Sub-S? Is he just out of luck, year after year? Response: The check to pay federal taxes does constitute a dividend. For readers not familiar with the situation, let me create an example that I believe puts flesh on Karen's question. XYZ corporation, an S corporation, had taxable net income in 2004 of $100,000; however, its board of directors voted to pay only $30,000 in dividends this year. Thus, shareholder Z, who owns only 10% of the corporate receives a 2004 dividend of $3,000; however, he must report $10,000 in income from XYZ corporation on his 2004 federal 1040 which is allocated to him through the K-1 form he receives from the corporation. This is what Karen is upset about. As long as the corporation has business reasons to retain the income in the business (which is very easy for a corporation to establish), the example given above is not only lawful but very common. Why would anyone invest in a Sub S? Entire books have been written on that subject so I won't comment on it other than to say, basically, the advantage is one level of taxation on business profits as opposed to two. The problem is not the Sub S structure, it's being a minority shareholder. A minority owner in any small business must trust that the majority will making decisions regarding the business that he/she agree with (or can live with) as the minority shareholder basically has no recourse other than to sell (and selling minority interests in closely held businesses is extremely difficult). Thus, it is very important from the outset for prospective minority shareholders to get a clear picture of the direction the majority shareholder wishes to take the company and details on such issues as dividend distributions prior to investing. Submitted: 4-27-2005; Karen, Pennsylvania Response: 5-4-2005; JJR Add A Comment |
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