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S-Corp distributes large share of profits each year. CFO…

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S-Corp distributes large share...

S-Corp distributes large share of profits each year. CFO allowed some shares to be bought after quarter, but allowed distributions for immediate preceding quarter. When shares were sold in early part of year, CFO distributed only based on income up to that quarter. Additional distributions were made in greater percentage of income in later quarters. Those who sold shares, did not received anything so weighted distributions were not done. Tax returns paid for partners for state returns were deducted from return and given to shareholders as tax credits for their personal taxes. Tax paid for them were not classified as distributions. So larger shareholders given credits, smaller ones nothing. CFO knows this is bad, refuses to correct, as refuses to amend returns for IRS penalties deducted in error on previous returns. Company's shareholder agreements, etc. are based on C-Corp, there is no provision for rights for equal distributions. The figures we are talking about are substantial in dollar terms. Has the Company terminated S-Corp election? I would mention that this is many years old in the way things have been done. Board members got back dated stock purchase dates to get distributions.

Accountant's Assistant: The Accountant will know how to help. Is there anything else important you think the Accountant should know?

Is there a way I could turn them into IRS and get a reward?

Submitted: 5 months ago.Category: Tax
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2/6/2018
Tax Professional: Lev, Tax Advisor replied 5 months ago
Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 33,115
Experience: Taxes, Immigration, Labor Relations
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You definitely may report a suspected fraudulent activity to the IRS.

The IRS Whistleblower Office pays money to people who blow the whistle on persons who fail to pay the tax that they owe. If the IRS uses information provided by the whistleblower, it can award the whistleblower up to 30 percent of the additional tax, penalty and other amounts it collects.

The law provides for two types of awards. If the taxes, penalties, interest and other amounts in dispute exceed $2 million, and a few other qualifications are met, the IRS will pay 15 percent to 30 percent of the amount collected. If the case deals with an individual, his or her annual gross income must be more than $200,000. If the whistleblower disagrees with the outcome of the claim, he or she can appeal to the Tax Court.

The IRS also has an award program for other whistleblowers - generally those who do not meet the dollar thresholds of $2 million in dispute or cases involving individual taxpayers with gross income of less that $200,000. The awards through this program are less, with a maximum award of 15 percent up to $10 million.

In addition, the awards are discretionary and the informant cannot dispute the outcome of the claim in Tax Court.

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Customer reply replied 5 months ago
How about the distributions, etc?
Customer reply replied 5 months ago
S-Corp distributes large share of profits each year. CFO allowed some shares to be bought after quarter, but allowed distributions for immediate preceding quarter. When shares were sold in early part of year, CFO distributed only based on income up to that quarter. Additional distributions were madein greater percentage of income in later quarters. Those who sold shares, did not received anything so weighted distributions were not done. Tax returns paid for partners for state returns were deducted from return and given to shareholders as tax credits for their personal taxes. Tax paid for them were not classified as distributions. So larger shareholders given credits, smaller ones nothing. CFO knows this is bad, refuses to correct, as refuses to amend returns for IRS penalties deducted in error on previous returns. Company's shareholder agreements, etc. are based on C-Corp, there is no provision for rights for equal distributions. The figures we are talking about are substantial in dollar terms. Has the Company terminated S-Corp election? I would mention that this is many years old in the way things have been done. Board members got back dated stock purchase dates to get distributions.
Tax Professional: Lane, JD, CFP, MBA, CRPS replied 5 months ago
Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 14,622
Experience: Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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Hi. My name’s Lane. I see you've asked for a different expert

I hold a law degree, with concentration in Tax Law, Estate law & Corporate law, an MBA in finance, a BBA, and CFP & CRPS (Chartered Retirement Plans Specialist) designations, as well - I’ve been providing financial, Social Security/Medicare, estate, corporate, non-profit, and tax advice, since 1986.

Bear with me just a moment.

I'm reviewing your question now and typing up my reply. I'll post that in just a few moments. Then, let me know if you have further questions on this.

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Tax Professional: Lane, JD, CFP, MBA, CRPS replied 5 months ago

You certainly have a cause of action for a direct claim or a derivative suit.

...

But, unless the entity ceases to qualify as a small business corporation or its passive income exceeds the passive income limitation OR ceases to qualify because of the requirements under Sec. 1361(b), you likely don't have a termination here.

...

A direct claim is often used by shareholders in small corporations, particularly with minority shareholders who are alleging unfair treatment at the hands of the majority shareholders. Here, the individual shareholder is seeking redress of wrongs committed by the corporation’s board or other shareholders that directly affect the individual shareholder.

...

Other causes of action that can be brought through direct action are fraud, conspiracy, and breach of statutory duties

...

Derivative suits, however, are claims that belong to the corporation, brought by a shareholder on behalf of the corporation because the corporation’s management is either unwilling or unable to do so.

...

The shareholders filing the suit do so as a representative or “friend” of the corporation. It is an effective method of taking action when a shareholder believes management should or shouldn’t have done something. It can also be used to expose fraud and other breaches of fiduciary duty that occur within the corporation.

...

The derivative suit is likely the best course of action here as it can be particularly crucial when the fraud is entrenched within the corporation and the perpetrators may also be the management themselves.

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Tax Professional: Lane, JD, CFP, MBA, CRPS replied 5 months ago

Please let me know what questions you have from here.

...

Lane

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Customer reply replied 5 months ago
I think the issue is that by paying different distributions that the S-Corp has established two sets of stocks and thereby has terminated. Treas Reg section 1.1361-1(1)(2)(i). And that by that they are subject to C corp rates. Thus they owe about $70 in taxes per year for many years.
Tax Professional: Lane, JD, CFP, MBA, CRPS replied 5 months ago

That's a creative interpretation of two "classes" of stock.

...

Remember that only controlling shareholders determine distributions. It's distributive share of profits (what flows through the K-1) that MUST be in proportion to ownership.

...

But you have a VERY good case that the officers/managers are in breach of duty to be fair

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Customer reply replied 5 months ago
The proportionate part is the issue. They favored themselves in that matter. I am thinking if I turn them in, that I can get a lot of money.
$3.7M in taxable income in one year x 35% tax rate x whatever the IRS gives me. I have complete documentation.
Tax Professional: Lane, JD, CFP, MBA, CRPS replied 5 months ago

I can get there

...

Under Treas. Reg. § 1.1361-1(l)(4), (one class of stock rule) ... "A corporation is treated as having only one class of stock if all outstanding shares of stock of the corporation confer identical rights to distribution and liquidation proceeds."

...

We certainly can infer the general rule that distributions from S Corporations to shareholders should be proportional to each shareholder’s ownership interest.

...

Have you seen this example in the regs?

...

"S, a corporation, has two equal shareholders, A and B. Under S’s bylaws, A and B are entitled to equal distributions. S distributes $50,000 to A in the current year, but does not distribute $50,000 to B until one year later. The circumstances indicate that the difference in timing did not occur by reason of a binding agreement relating to distribution or liquidation proceeds… the difference in timing of the distributions to A and B does not cause S to be treated as having more than one class of stock."

...

Notably, it's the LACK of existence of a binding agreement that allows timing differences - must wonder if this is what they're hanging their hat on.

...

There are a couple of other PLR's that allowed the S-Corp not to lose its status as well, if memory serves.

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Customer reply replied 5 months ago
It is not a timing difference. there is no make up. The IRS has been generous if the company timely discovers there own mistake and issues corrected distribution (years here have passed) and stock agreement says entitled to equal distribution (not such in this case), and state law requires it (not here, Idaho). So I think I have good argument. Plus in 2008 they paid phony rent to comp board members who owned the old building and sold it to the county. They cried they needed bigger profit from sale.
Tax Professional: Lane, JD, CFP, MBA, CRPS replied 5 months ago

I think you have 'em

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Tax Professional: Lane, JD, CFP, MBA, CRPS replied 5 months ago

(just wanted to push through the possibilities) ... All in ALl it sounds like you have bad actors here AND that intent (knowledge, willfulness) can be shown

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