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Ask a Lawyer -- Corporations
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Question: I am one of 5 equal shareholders in a Sub-s corp. The other 4 are my brothers. Myself and one other brother are the only active employees of the corporation. We also make up 2 of the 3 directors. For 15 years I have been able to when not forced to by economic conditions to show a slight loss or breakeven for each year in business. This past year was one of our best years in business and resulted in a gain of $55k. This brought each Shareholders share to $15k (initial investment $10K). This is the first time that it has grown above the initial investment. This profit also occurred because myself and the other working brother did not take a huge bonus. Having a business background (the only one of us)I did not want to distribute any of the profit but rather save it in the corporation to buy new equipment and prepare for any downturn. My other director agreed. The 3 non-working brothers are squawking. Do I have any obligation other than a "moral" one to distribute any of this profit? P.S.- The others brothers use to be employees in the past and received equal salaries back then. Response: That's a long question but the issue is fairly focused. I'll respond with general corporate principles; however, you'll need to consult with a Georgia attorney to see how the courts in your state have interpreted these principles. Generally, there is no duty on the part of a corporation to pay dividends as long as the corporation has reasonable grounds for retaining the profits. There is a federal accumulated earnings tax that applies to the unnecessary accumulation of profits in a C corporation; however, we are dealing with an S corporation so that is not an issue. The biggest problem I see with paying no dividend is that the shareholders are going to be taxed upon their distributable share of S corporation income regardless of whether or not a dividend is paid. That would amount to something of a backdoor contribution of capital by the shareholders (i.e., they are going to have a personal income tax liability for profits they never received). A prior question I answered sets out similar facts on this issue. Partners in a partnership owe a fiduciary duty of loyalty and good faith to one another. In some states (I don't know whether Georgia is one of them) Sub S shareholders have been held by the courts to owe a similar duty to one another as that of partners. I cannot say whether or not the failure to at least pay dividends equal to the tax liability would violate this fiduciary duty but it would be an issue to be concerned with. If you are adamant about paying no dividend (even to meet the shareholder tax liability that flows from the profits), then I would take the issue to a local corporation attorney to get an advisory opinion on the issue. Submitted: 6-01-2005; Ben, Georgia Response: 6-15-2005; JJR Add A Comment |
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