We are four shareholders of a professional S corporation in the United States. Each of us owns 25% of the corporation.

Each shareholder keeps track of his own billable hours, and the corporation bills the clients on a monthly basis. When a client pays for the work performed, the payment is credited to the particular shareholder who performed the work. Since all payments received by the firm are allocated to a particular shareholder, no money actually belongs to the firm as a whole.

Each shareholder is paid a salary, so long as that shareholder maintains a positive balance. A shareholder may, but is not required to, withdraw additional money at any time from his account, which is then run through payroll. A shareholder who has a negative balance is not allowed a salary.

The costs of running the corporation are split evenly (25% each) between the shareholders.

We have a situation in which two of the shareholders have generated a substantial amount of money - and have left that money in the corporation - while the other two have negative balances.

Our CPA has provided us with Form 1120 Schedule K-1s, which divide the firm's balance evenly between the four shareholders (Schedule K-1, Part 1, line 1). The balance actually belongs to the two profitable shareholders; the two shareholders with negative balances do not own any part of that money, and will not receive any part of it. However, based upon the K-1s issued, those two shareholders with negative balances would still have to pay taxes on their reported fourth of the balance.

Question 1: Was the CPA correct in simply dividing the balance equally, or should the CPA have prepared different K-1s showing how much of that balance actually belongs to each individual shareholder?

Question 2: If the balances are to be divided equally, is there someone else that the two shareholders with negative balances can account for their lack of share in the income?

Any help greatly appreciated.

Thank you.

Question 1: Was the CPA correct in simply dividing the balance equally, or should the CPA have prepared different K-1s showing how much of that balance actually belongs to each individual shareholder?==========>> as you can see, an S corp is not a MMLLC; The IRS requires shareholders who actively participate in the corp?s operations be paid a reasonable wage.if not they are no longer employees of the S corp. An S corp that does not pay a reasonable compensation to its shareholders/employees avoids payroll taxes. The payroll tax savings, of course, raises an issue with the IRS
income, losses, and other items, are passed-through an S corp to each of the 4 shareholders according to his/her percentage of ownership in the s corp. Unless you are just a passive investor but are active in running the S corp, then the IRS will consider you a reg W2 employee of the S corp. In that case, under IRS rules, you must receive at least some of your share of the corp?s profits in the form of a salary since the S corp is not a MMLLC, a partnership I mean. The same holds for any other shareholder-employees as well as for any corp officers regardless of whether they?re also shareholder. With small, closely-held businesses in particular, it?s common for the few shareholders to also run the business, so it?s important to be aware of the requirement to pay shareholder-employees a salary. Unlike distributions, shareholder-employee salaries are subject not only to the personal income tax but also to federal employment taxes.though It?s up to the people who run an S corp I mean its officers and directors, to decide how much salary to pay the corp?s employees, since An S corp shareholder performing more than minor services for the S corp will be its employee for tax purposes.

Question 2: If the balances are to be divided equally, is there someone else that the two shareholders with negative balances can account for their lack of share in the income?=======>As mentioned above; unlike MMLLC members, S corp shareholders don't pay self-employment aka seca taxes on their distribution from the corp. But S corp owners who work as employees must be paid a reasonable salary. So, it depends; s corp shareholder has neg income only when the s corp has neg income.