This time of year, shareholders in an S Corporation and partners in a partnership receive Federal form K-1 showing how much income they must report when they file their income tax return in April. Where stockholders or partners sometimes get confused is that the income required to be reported is irrespective of how much cash was distributed to them. Therefore it is possible to be in a situation where the income to be reported far exceeds the cash distributed. Consequently the tax paid on the income comes out of the stockholder or partner’s own funds and not the corporation or partnership. Sometimes this is referred to as “Phantom Income.”
When a shareholder / stockholder squeeze out or partner freeze out is in play, this is one of the major tactics applied by the majority against the minority. Clients always ask “can they do that?” “How am I supposed to pay my taxes on income I never received?” “There must be something wrong with that.”
In Illinois this issue does not come through as “distributing tax money.” Rather, it is looked through the eyes of Declaring Dividends. Therefore if there is a history of distributing sufficient money (making dividend distributions) to pay taxes on the income to be reported on a shareholders tax return then withholding those distributions could be interpreted as the majority shareholders oppression of the minority. The opposite is also true. If there is no history of distributing money to pay taxes (declaring dividends) then it is difficult to argue the majority stockholders are oppressing the minority shareholders.
Horowitz Law Offices represents individuals in squeeze outs, freeze outs and other disputes. You are welcome to contact us at (312) 787-5533 or firstname.lastname@example.org