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We need to explain the K1 report to new shareholders (whom

have not had this type...
We need to explain the K1 report to new shareholders (whom have not had this type of exposure before). The new shareholders are non-voting children of the long-time owner of the business. I find the K1 to be rather confusing to most anyone other than tax professionals. Do you have a simplified method you are able to suggest . . . making it somewhat clear to the recipients? Your advise would be appreciated.
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1/2/2012
Jax Tax
Jax Tax, Tax Attorney
Category: Tax
Satisfied Customers: 1,408
Experience: JD, LL.M in Business and Taxation, IRS Enrolled Agent. Expert in Business and Tax Transactions
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Jax Tax : Certain businesses are not subject to income tax which is generally a good thing. When this happens, someone must pay tax on the business income. So, the business files an 1120s or 1065 which produces a K1.
Jax Tax : A K1 is similar to a w2 or a 1099. It simply show what your portion of the business income / loss / or other reductions is.
Jax Tax : Since the business is not taxed, the owners must report the profit or loss on their personal return.
Jax Tax : There is a small difference here than typical w2 income. That is the K1 reflect the business profit or loss not exactly what the individual owners actually receive.
Jax Tax : For example. A business has profit of $100k and two owners. The k1 to each will show $50k profit which will be taxed. This does not mean the owners received $50k only that the business earned it. The business could retain the entire $100k and make no distributions. The good side is that later down the road if the $50k is distributed, it is not taxed because it already has been.
Jax Tax : To summarize, tax is based on business profit passed on the k1. Distributions themselves are not generally taxable.
Jax Tax : I want to point out that the children cannot be non voting shareholders. This is a violation of the rules and will change your tax status. All owners mustbhave the exact same shareholder rights. This is not negotiable. The last thing you want is one getting older and getting a lawyer and owning the business when it is all said and done.
Jax Tax : Not to mention the IRS changing your tax status.
Jax Tax : There can be only one type of stock which must have the exact same voting rights.
Customer:

Yes, understood, it is daunting though to tie the K1 to the book results of the company. And in this case, the distribution will be for their estimated tax liability.

Customer:

I understand one type of stock, however on advice of attorney, we were told we could have voting and non-voting shares. Do you have a reference I could read on this, so I am clear we are not in conflict with any regulations? Thanks

Jax Tax : It is good you ensure the estimates are covered and I am working on the cite for the voting issue.
Jax Tax : Section 1361 is consistent with your attornies statement regarding voting rights. Alley having different voting rights does not.disqualify a sub S. This seems to stem from the LLCs ability to make such fordable arrangements. But, if an LLC, you would have members not shareholders so I am assuming to S election was made by a corporation.originally. This may cause.issues. An LLC uses a membership agreement to set forth such rules.
Jax Tax : A corporation would typically do so by issuing different classes of stock.
Jax Tax : To summarize, I would just run this by he attorney to male 100%. Here is the statute language.
Jax Tax : (4) Differences in common stock voting rights disregardedFor purposes of subsection (b)(1)(D), a corporation shall not be treated as having more than 1 class of stock solely because there are differences in voting rights among the shares of common stock.
Jax Tax : I will assume he is correct but it is worth talking to him about unless you are an LLC which case you are fine.
Customer:

We are a S Corp. Thank you very much for your candid comments.

Jax Tax
Jax Tax, Tax Attorney
Category: Tax
Satisfied Customers: 1,408
Experience: JD, LL.M in Business and Taxation, IRS Enrolled Agent. Expert in Business and Tax Transactions
Verified
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