S corp shareholder taxed on "phantom income" distribution?

Question

I am a shareholder of a company registered in New York. Each year, I get a Schedule -1 1120S form stating the profit/loss of my share, for that year. For the profit years, I never received any actual cash nor stock distribution from the profit. All the profit were "supposedly" reinvested back to the company. Is it true that I am still obligated to file my "phanton income" in my personal tax return,even that I never received a single penny? If it's true, I really don't think it's fair. Is there anyway to prevent paying tax on these "phantom income"?

Answer 1

since a S corp cannot legally retain any earnings there should be no "phantom income"
The S corp files a form 1120S and a K1 showing to the IRS each shareholders % of profit or loss. If you have a portion of the gain or loss reported to you on a K1, you include that amount of Schedule E of your tax return.

A C corp can retain any amount of it's earnings, a S corp
can not retain any earnings at the end of the tax year.

since the K1 is filed with IRS showing your share of profit or loss, you must show that amount on your tax return.

Answer 2

Why didn't you receive any money from the corporation? As a shareholder, you have the responsibility to look out for your investments. You don't have the ability to force the company to pay you dividends, but you do have the right to vote for the board of directors. If you believe the money was misappropriated, then you may have a right to bring an action against the officers or directors who allowed that to happen. However, the entire reason there are S corporations in the first place is so that the responsibility for paying tax on income can be passed on to the shareholders, so you are stuck with that obligation.

There's nothing unfair about requiring you to pay tax on your share of profits; you agreed to that when you acquired your stock. The profits belong to you and if you allowed yourself to be put in a situtation where you can't get your hands on them, then it's a lesson on reading the fine print and knowing what you're investing in.

Answer 3

Nope. That is how S-Corps work. You pay taxes on your share of the income whether you receive cash or not.

Most S-Corps will distribute enough cash to cover each shareholders tax on the income but there is no requirement that they do so.

Answer 4

An S-Corp is a pass-through entity. The net profit is divided among all shareholders and is fullly taxable to you whether you receive it or not. There's no way to avoid that.