Even If You Wuz Robbed

Despite his claims that his former fellow shareholders LL and WJ (Court’s nomenclature) looted the S Corp he cofounded, and ripped him off by stealing his share of corporate passthroughs, James J. Maggard, star of James J. Maggard and Szu-Yi Chang, T. C. Memo.  2024-77, filed 8/7/24, is still taxable on his share of the corporate income, deductions, and credits.

JJ claims, when he blew the whistle on the looters,  the Ogden Sunseteers suggested the unequal division of goodies might’ve forfeited the corporation’s S status, relegating it to C Corp and negating any poassthrough. The disproportionate grabs might violate the one-class-of-stock requirement in Section 1361(b)(1)(D), in the absence of which a corporation cannot elect or maintain Sub S status.

However, the caselaw and Reg. Section Reg.§ 1.1361-1(l)(1) tell us that unless the organic corporate documents (certificate of incorporation and bylaws) provide for unequal rights to distributions and liquidation proceeds, anything goes. JJ and his fellow shareholders, past and present, never changed those documents to provide otherwise than for a single class of stock with identical rights.

“The IRS has said it won’t treat any disproportionate distributions made by a corporation as violating the one-class-of-stock requirement if the governing provisions provide for identical rights. Rev. Proc. 2022-19, § 3.02, 2022-41 I.R.B. 282, 286.” T. C. Memo. 2024-77, at pp. 8-9. The idea is that, if the shareholders aren’t trying to duck the one-class rule (on which IRS will not opine), they can make what deals they like.

Judge Mark V. (“Vittorio Emanuele”) Holmes is sympathetic to JJ, who was well and truly plundered, but the law is the law.

“The regulation plainly states that uneven distributions don’t mean that the corporation has more than one class of stock. Treas. Reg. § 1.1361-1(l)(2) (‘[A] corporation is not treated as having more than one class of stock so long as the governing provisions provide for identical distribution and liquidation rights . . . .’). We recognize that this can create a serious problem for a taxpayer who winds up on the hook for taxes owed on an S corporation’s income without actually receiving his just share of its distributions. This is especially problematic when the taxpayer relies on the S corporation distributions to pay these taxes. Worse yet is when a shareholder fails to receive information from the corporation that he needs to accurately report his income.” T. C. Memo. 2024-77, at p. 9.

And of course the looters gave JJ bogus information, based upon which he filed his taxes, and made sure he couldn’t see the real books.

Hard though it is, the “law is ironclad” on this issue. JJ must pay tax on cash he never got, because it was stolen by his fellow shareholders.