Distributing S-Corp Gains/Losses to 2 Partners?

Question

My wife and her partner set up an s-corp for their business which was started during 2007. They definitely did not turn any profit during their first year, but have a number of expenses and some revenue. Each of them paid for a variety of the expenses out of their own pocket prior to setting up a joint account for the business.

My question is how the s-corp gains (or losses in this case) flow through to both their individual tax returns. Do they fill out a combined form (I think its 1120S) and then split the assumed loss on both of their individual tax returns? Is this done 50/50 or is there some other method to do so?

What if the expenses were not shared equally during the year? Do they need to calculate how much they spent each and reconcile that with each other offline, so that when they fill out the tax forms, the loss that each receives is equal in actuality in addition to theoretically?

Thanks for your advice.

To respond to one of the answers:

For most of the expenses this year, my wife or her partner have paid for business expenses out of their own pocket. Until recently, there was no revenue and no investors, so there were no funds to reimburse these expenses.

Sales have now started and there is limited revenue that is being deposited into a 'corporate' bank account. Going forward, they will pay bills from this account, be reimbursed from this account, and deposit income from sales into this account.

For this year, their out-of-pocker expenses were not equal. I assume they need to work this out offline (i.e. before they start tax calculations) so when the loss for the year is calculated, they can each take 50% (as they are equal shareholders) on their personal 1040s.

I hope this helps and thanks again.

I was referring to partners in the 'working together' sense, not in the legal sense. Yes, they have filed a form 2553 and are incorporated as a S-Corp.

Thanks to all for the input - very helpful.

Answer 1

Taxreff pretty much answered the question, but I will expand on the reconcilation of the expenses that were paid from each partners personal funds. These expenses need to be split 50-50. If your wife put more into the business than her 50% and the partner can not pay your wife the difference then you need to book a note payable shareholder on the S-corps books to your wife for the difference. Or viceversa. Then when the funds are available within the S-corps bank account the S-corp can distribute the funds to your wife ( in this example) in order to settle the discrepency and make the partnership a true 50-50 percentage. This distribution will not be taxable since it is repaying a debt.
As far as reporting goes, you are correct by filing a 1120S form and each partner receiving a K-1 with 50% of the income and 50% of the expenses to be reported on their personal 1040 tax returns. As always, contacting a tax professional in your area is a great idea, especially when starting a new business. Hope this helps out. Have a great Holiday season.

Answer 2

One of the disadvantages of S corporations is that profit/loss and distributions must be made in accordance with stock ownership percentages. If each shareholder owns 50% of the outstanding shares, each must report 50% of the profit/loss on their respective K1.

One way to handle the expenses is to set up an accountable plan. In that way the owner/employees are reimbursed for their expenses by the corporation. The reimbursements are deductible by the corporation and not taxable to the owner/employees.

Answer 3

A corporation doesn't have partners, it has stockholders.

Are you sure you have an S Corporation, and not a partnership?

If the entity was incorporated, was a Form 2553 filed with the IRS to elect S status?

This is why the services of a competent tax professional are essential.

Answer 4

The profit or loss is split based upon your percentage ownership of the corporation. Not sure I understand the question about expenses. Were company expenses paid with personal funds? Please clarify the question.