Discussion:Strange S-Corp K-1 - Questions

My client received an S-Corp K-1 showing 13,600 in Box 1 and the same amount in Box 16 (D). Shareholder's ownership says 33.33%. He was told that the amount represents the amount of distribution of profits to him before W-2 wages were begun and all 3 shareholders received the same amount. Seemed strange to me that profit in the 3rd Qtr of the year was the same at year end so I asked for and received a copy of the tax return.

There are 3 shareholders with ownership % of 33.33/33.33/33.34. My client and the other 33.33% owner had identical K-1s (18% of profits each). The 33.34 ownership shareholder's K-1 shows the other 64% of Net Income as well as 100% interest income, Sec 179 Deduction and non-deductible expenses. His Box 16(D) shows 18,600.

I would have thought all of these items should be split 1/3 to each shareholder. Is there something else I need to learn about S-Corp reporting?

There is an allocation (weighted average)that's done if ownership % changes during the year.

If interests do not change during the year, each shareholder gets their % of each and every item of income or expense.

The K-1 is not marked final. The incorporation date says 7/10/07 and the S-Election shows 1/1/08. Per the balance sheet, '07 balances were "Loan to Shareholder" = 1,500 and Capital Stock + 1,500. Those numbers remain on the '08 B/S along with cash, fully depreciated assets (Sec 179) and retained earnings.

Per Schedule Q, B1 on the CA return, there was no change in control or majority ownership during the year.

One shareholder got 64% of the NI and the other 2 got 18% each. Shouldn't the Sec 179,Interest income and nondeductible expenses be split on the same basis? Looking at the CA return, the CA minimum tax adjustment only affects the 64% shareholder's K-1.

It sounds to me as though the preparer of the S corp return is treating it like a partnership, perhaps because the underlying organization is an LLC.

I'd ask for an explanation from the preparer of the S corp return. What was he/she thinking? If the S election is invalid, the default will be not to partnership (flowthrough) treatment even if the entity is actually an LLC, but to C corp. That probably won't be a good answer for your client.

All 3 started the business in 2008. One 33.3% shareholder (#2) left 11/30/08. My client (#3) and the 33/34% shareholder (#1) were still shareholders at 12/31. My client left 6/30/09. During 2009 shareholder #1 did a solo job and ran the income through the S books (everyone knew this was happening) so his distribution was $5k more than the other two.

Preparer supplied 2 spread sheets of possible allocations. The first was closest to correct. That does show allocations until 11/30 with income at that point (less the outside job) split 3 ways and the amount of Dec income that would have been split 50/50. There is no mention of the Sec 179 that was all allocated to #1 on the tax return. However, the 1120S was prepared using the "second method".

Return was not prepared until after my client said he was leaving in June '09. For some reason, the preparer seems to have looked at the NI thru 6/09 and prepared the '08 return with information in mind. December income that should have been split 50/50 was high. Then the next 6 months was apparently low enough that, after payroll, there was a net loss.

Preparer says he and #1 decided to just give #2 and #3 shareholders '08 K-1s reporting only their distributions as taxable income so that they "would not be affected on their 2008 taxes except for actual distributions received". I think he is confused because he says if he had allocated 50% of the Dec income to my client then he would have been entitled to a distribution of that amount and when he left in June, when there was a loss, he would have been obligated to "repay" that distribution to cover the 2009 loss.

Lastly, my client will get a 2009 K-1 showing -0-.

I know this is wrong but since I am not the 1120S preparer and the actual preparer (a CPA) is convinced he acted correctly, how should I proceed? If I just amend my client's returns (1040 for him plus CA joint with his partner) based upon the K-1 received, what are the chances that the 1120S will never be questioned by IRS? What is the downside to my client if the 1120S is pulled for audit?

Does anyone have any thoughts on this mess? I will be at an update seminar over the next three days and hope to find some ideas/advice there as well.