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A friend of mine is involved with an organization as an employee but also owns a 5% equity stake in the organization.

The organization is a S-corp. They want to pay 5 members an equal owner draw while maintaining disproportionate equity shares. So imagine 4 members owning a 23.75% stake, while my friend owns just 5%.

The general question here is: can owner draws be paid to any member regardless of equity stake? Also, how will each member's draw be taxed (personal income tax, capital gains)?

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Technically speaking, S-Corps don't have owner "draws", instead they have owner "distributions", and yes, they must be paid equally based on equity stake. For example, if the company decides to distribute $1000, exactly $50 of it must go to your friend, and in your example each of the other 4 owners would get exactly $237.50.

In general, with an S-Corp, even though distributions are reported on the company tax return, taxes are not paid on distributions, but instead on profits. If the company profits $1000, your friend would pay tax on the $50 as income regardless of whether that money is distributed. (The other owners would each pay tax on $237.50 of income.) The exception to this rule is if the company distributes more money than it actually has (by taking on debt) then shareholders would pay capital gains on the amount of the distribution.

  • Can you think of any tax situation where the scenario I described in my post is possible? – fromspace Apr 1 '18 at 19:30
  • Distributions must be paid according to equity share. However, W2 wages can be paid however the company sees fit. If they want to equalize payments without adjusting the stock percentages they could pay your friend additional wages to compensate. That may not be ideal though since wages cost both the company and employee FICA taxes... – TTT Apr 1 '18 at 19:55
  • What about in this situation: an LLC taxed as a partnership? Thank you for your insights btw. – fromspace Apr 1 '18 at 20:45
  • @fromspace - sort of. A "special allocation" allows a partnership to pay out members a disproportionate amount of profits compared to their ownership share. However, special allocations must be approved by the IRS and are typically only used when one partner has contributed significantly more capital and wants to get paid back more quickly. Another common way is with "guaranteed payments". These are basically treated like additional salary to the member. But, (basically) all profits in a partnership LLC realize FICA taxes so you don't gain anything compared to the S-Corp additional salary. – TTT Apr 2 '18 at 3:20

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