Discussion:A Girl Needs Cash

From TaxAlmanac, A Free Online Resource for Tax Professionals
Note: You are using this website at your own risk, subject to our Disclaimer and Website Use and Contribution Terms.

From TaxAlmanac

Jump to: navigation, search

Discussion Forum Index --> Advanced Tax Questions --> A Girl Needs Cash


Discussion Forum Index --> Tax Questions --> A Girl Needs Cash

Ckenefick (talk|edits) said:

8 October 2013
Ok, maybe I ripped that title off from a famous book...Anyway, I have this 1040 client. A real hot Russian. Born in the USA, though, and has always lived here. She's a 15% minority shareholder/employee in an S-corp. She feels like she's under appreciated, like she's not being paid enough and like she's not getting enough in the way of Shareholder Distributions (can you say zero?).

S-corp recently signed a semi-big contract with a customer. The work on this contract will start mid-October and will end around Christmas time. The customer is prepaying the full contract amount up front. Pretty nice, IMO. Anyway, client goes to the majority shareholder and says, "I'd like a sizeable bonus seeing that we just signed that semi-big contract. I haven't gotten a raise in years and I need some cash. My accounting fees are real high for one thing." Majority shareholder basically laughed at her. But, being a Relentless Russian, she asks about a pro-rata Shareholder Distribution. He says, "Haven't you read the newspapers? Women make less than men. I intend to keep it that way."

This all happened about a week ago and, fuming, that's when she called me. She says she is so mad at this point she's ready to give her stock back to the corp and quit. She has no employment contract, there's no shareholder agreement, no buyout agreement, etc. Real informal. She thinks he's angling for her to leave, so he can keep all the loot for himself. She thinks he's just gonna leave that big profit in the corp bank account and roll it over to next year - no distributions to either of them and no big bonus to him either - he's smart and wants her to pay tax on money she might never get. Plus, being an enterprising Russian, she's already got a side business with a friend (another hot Russian), which is showing promise.

In any event, I gave her one small bit of advice, without really thinking too hard about it. Today, I get an email from her: "Chris...here's a copy of the letter. I just e-mailed it to that a-hole. I also sent a copy of it to him via certified mail, return receipt requested. The stock certificates have been signed over."

Well, guess what the letter said? It said that she transferred her shares to a partnership - that partnership that's owned by her and her friend.

Oh boy! I can't believe she actually did it! Holy crap!

What's going to happen? Please, I need an answer asap!

Doug M (talk|edits) said:

8 October 2013
What's going to happen?

One hot Russian is going to get a raise.......

PollyAdler (talk|edits) said:

8 October 2013
As they say in the High Courts, I must recuse myself from this discussion. <blush>

Death&Taxes (talk|edits) said:

8 October 2013
Looks to me like she destroyed the S Corp since a partnership can't be a shareholder....or at least she is threatening to do so which sounds like a form of blackmail. Hope she is slightly more sound mentally than your impersonator.

Ckenefick (talk|edits) said:

8 October 2013
Is it that easy - just flip ownership to an impermissible shareholder...and that's that?

Death&Taxes (talk|edits) said:

8 October 2013
I assume a buy/sell shareholders agreement has never been signed? Many that I have seen will not permit transfer without the corporation having first dibs on buyout. If there is one, then we are not in the realm of taxes but rather a civil matter to be heard in District Court in Yaroslavl.

Ckenefick (talk|edits) said:

8 October 2013
Many that I have seen will not permit transfer without the corporation having first dibs on buyout.

Seems that that is a *really* good idea. As noted in the OP, however, things were informal...no transfer restrictions, no shareholder agreement, etc.

If there is one, then we are not in the realm of taxes but rather a civil matter

What about that...

PHIL MOODY (talk|edits) said:

8 October 2013
In reality, she only gets the income and no cash. The majority owners will take their football and go home (ie: form new entity, drain the old entity of cash thru salaries and director fees).

PollyAdler (talk|edits) said:

8 October 2013
I don't want to say anything to get this young lady in trouble, because I feel like we belong to same Union, if you know what I mean.

" Many that I have seen will not permit transfer without the corporation having first dibs on buyout."

If that is typed on the stock certificate, then the corp is a genuine "close corporation". Now, keep in mind, I have not looked at a book on corporations law in my state for at least 5 years now.

As far as tax and the close corporation, I saw a blurb about it one time in Kiplinger tax letter or some such, and I think they have some benefit (other than just the legal side of it), but I can't remember a thing about it. I leave it to the professors here to argue over.

Ckenefick (talk|edits) said:

8 October 2013
What income? She transferred her shares prior to the "semi-big" income hitting...

The majority owners will take their football and go home (ie: form new entity, drain the old entity of cash thru salaries and director fees).

Well, that remains to be seen. Interestingly, she says the e-mail to the a-hole got bounced back...so a-hole doesn't know about the ownership switch yet. I told her to hold off on resending it...thinking she might want to notify a-hole about the ownership switch after year-end...and thinking you guys might have some ideas about all of this...

PollyAdler (talk|edits) said:

8 October 2013
Oh, I remember the fact pattern in Kiplinger, if daddy wants to set son up in a corp. for instance, Kip suggested it be a close corp. because when it inevitably went bust (not everyone is Bill Gates) then the father could take a better loss...something along those lines. I have no idea if my memory is correct on this. Just an aside anyway.

And can a close corp. be an S. Corp? I suppose it can. Those categories I don't remember either. Anyway, asides, asides.

Noobie (talk|edits) said:

8 October 2013
Well, first of all, his comment about inequality of pay, and his efforts to perpetuate the cycle is enough for a lawsuit... Although I personally would take my crayons and go home... But, if one were so inclined, she could A. Sue, B. Let the big client know what a bunch of Neanderthals they are dealing with, or C. My preference, back out of the S-Corp, and let them pay taxes on the money they are getting. Which also keeps her safe from libel and slander lawsuits.

Ckenefick (talk|edits) said:

8 October 2013
Well, first of all, his comment about inequality of pay, and his efforts to perpetuate the cycle is enough for a lawsuit...

He'll deny it. Employment at Will state anyway. He's the majority owner and can establish pay policies, dividend policies, etc.

Jakescia (talk|edits) said:

8 October 2013
Sounds like nominal probability that HR (Hot Russian) is going to ever get distributions, and absent a shareholders agreement requiring distributions, things could get a little tight---- ie cash flow-wise.-------paying taxes, especially if she waits for a known income balloon.

So......transfer the stock before the Oct beginning------or at least threaten it.

If other shs ignore her threat, at least if she carries thru, then she will still own a share of net assets, will have no taxes to pay related to the balloon of income in Oct--Dec, will have the capacity to sue as a minority shareholder if she so elects.

I probably would quibble with the use of a partnership, as compared to another S corp.......merely due to having to share ownership.........but if the value of the S interest was HR portion of the asset contribution....so be it, plus that would provide some business purpose to the transfer, as compared to mere vindictiveness------that element is for the legal community to handle.

Ought to be ample business purpose laying around for formation of corp if chooses to go that route.

Ckenefick (talk|edits) said:

8 October 2013
will have the capacity to sue as a minority shareholder if she so elects.

I'm more worried about her getting sued because of her vindictive, self-centered act. What do you think?

Noobie (talk|edits) said:

8 October 2013
She could always ask to call a shareholder's meeting, and ask for distributions. If they will hear none of that, ask to be bought out. If none of that works, I would follow Jake's path, or at least talk it over with a lawyer. She definitely does not want to be on the hook for the additional tax implications of the new contract. Then again, does she want to be out of a job, too? Besides, what are the laws in your state about voice recorders? If he is really that closed minded, it would serve him right to get sued.

Jakescia (talk|edits) said:

8 October 2013
CK

That is where the business purpose, supported by the history of the relationship as a shareholder, ought to leave her in a "business-like" position........as compared to being just a "gold-seeking bi...".

I have been called a "vindictive SOB" more than once by the opposing side, just for furthering a client's interests.....and have yet to be sued............. I guess it hinges on how she would package it that would determine the extent of her vulnerability.

Ckenefick (talk|edits) said:

8 October 2013
I'm more worried about her getting sued because of her vindictive, self-centered act. What do you think?

I'm worried about her fiduciary duties here, to the other shareholder.

Jakescia (talk|edits) said:

8 October 2013
CK

Well, I guess that is why a "real world" scenario would be a discussion with the other shs.......where are we going, what is going to be the cash flow requirements, why no distributions in past and will it continue into the future, etc etc and obviously would most likely not occur by the HR.......but by her trusted accountant, who, by the way, might be held to be not a disinterested party because of smelling large fees------

Eventually, a "compromise" (that is a word I learned in the Midwest, as compared to Wash DC) will result---or not result, but eventually a path will be set.

I would guess that such conversations---even if brief, and only long enough to hear a resounding "NO! HELL NO!" on the other end of the line would go a long way towards mitigation of fiduciary responsibilities......especially when it sounds like the other sh(s) are more or at least equal in "S corp sophistication". Surely someone in the past would have asked the question----- why am I paying taxes (if only a small amount), which means the corp is showing taxable income, when I am not getting distributions. Therefore, surely someone would have educated the "other" shareholders on the mechanics.........resulting in my thoughts being reinforced that the situation is one totally understood by the other shareholders, some of whom are getting salaries.

All of the above in summary----- it smells like her fiduciary responsibilities ended a long time ago.....but, just to be safe...... I would attempt another shot, albeit brief.

Ckenefick (talk|edits) said:

8 October 2013
There's no more discussions with the majority shareholder. Simply put, Hot Russian (HR) would like to stick it to the a-hole majority shareholder by forcing a termination of the S-election.

It seems it's real easy...almost too easy. So, Moral of Story #1 is: If you have multiple shareholder S-corp clients without buy/sell agreements, shareholder agreements, etc. wherein something like this could happen, you need to pull out the red phone and make some calls and insist that documentation be put in place.

Moral of the Story #2 is: Well, I'm not sure if there is a Moral #2 yet. But we can come up with it if we can answer these questions: Forgetting about the tax law for just a moment, what kind of ramifications might result from this selfish act by HR? What kind of fiduciary duty does HR have to the other shareholder? What other information might we need to make this determination?

Jakescia (talk|edits) said:

8 October 2013
An interesting thought----- what non-tax ramifications?

I have been pulled into two S corp shootouts, where there was no shareholder agreement.......and both were situations where the "minority" shareholder was being forced out by the others.

The first was when I was still playing with rubber duckies.....and did not have the sense to threaten the kill of the election. Two rather wealthy widows were attempting to force out the young operations manager, to whom they had given a 15% sh interest to keep him interested, and then decided he was doing such a good job, they did not want to share the goodies, so refused to vote to make any distributions. Ultimately forced him out.

The second is still going on.

The point is----- in both cases it would SEEM that the "fiduciary" relationship was killed by the majority shareholders first.......so the concern over the minority being the bad guy would SEEM to lose a lot of weight.

Earnings history vs distributions vs working capital needs vs ongoing salaries to those who were justifying drawing salaries......lots of circumstances that would seem to favor the majority being the bad guys first.

It would seem that "control" would play a heavy role in the determination of good guy/bad guy......as long as it could be shown that distributions would not draw/have drawn down cash to the point of harming the business, and giving due regard to the amount of cash the S corp would have had to shell out for income taxes had it been a C corp.

In my case.....it will be interesting as to the outcome........corp is showing 1.5 million net, with distributions being about 30%.........and the taxpayers individually would be in about the Fed + state 42% brackets. And the receivables/payables have pretty much leveled out, since it is a business where its sales capacity has maxed, except for price changes.

I suspect the loud minority sh will be bot out.

Ckenefick (talk|edits) said:

8 October 2013
There's a lot of "Seeming" in them there words...But it "seems" to me that the bad act of Bad Actor #2 perhaps can't be nullified, or otherwise minimized, by the bad act of Bad Actor #1. That is, seems there might be recourse by Bad Actor #2 against Bad Actor #1 with respect to #1's bad act. And, it seems there might be recourse by Bad Actor #1 against Bad Actor #2 with respect to #2's bad act. Two separate claims, if you will.

I'm not so much interested in any claim my client might have with respect to her boss underpaying her, not distributing cash, being an a-hole, being a chauvinist...etc.

I'm more worried about the *separate* issue of my client busting that S-election and what, legally, the a-hole could do to her in a court of law as a result of it.

Jakescia (talk|edits) said:

8 October 2013
Well, it would SEEM to me that the root problem is whether or not she is being damaged by a lack of distributions----and can show that----- you SEEM to not be concerned about that

I'm not so much interested in any claim my client might have with respect to her boss underpaying her, not distributing cash, being an a-hole, being a chauvinist...etc..........

SEEMINGLY, there would be no basis for litigation then by her, or even making a move that might invite litigation, such as breaking the S election, other than her nose getting out of joint......and there could be a myriad of reasons for that happening.....we have no idea where her nose might have been.......

I don't think a judge would listen very long to....."well, I am suing the majority shareholder not because of a relationship based on my stock ownership, but rather is was not SEEMLY the way he refused to give me a raise...even though it was only my perception that gave rise to the feeling of needing such raise........etc etc.

Or.....on the flip side.... "Judge, the reason I killed the election was because of getting my feelings hurt when the BIG CHEESE did not give me the raise I was expecting.......so I understand that my purpose in killing the election was not tied to my position of being a shareholder.....it was because I am a gold-seeking...."

So......if she is not interested in monetary enhancement due to monetary disenchantment as a shareholder, it would SEEM she is doomed to sitting by the fireplace while the sisters go to the Ball........or at least it would seem so.

Ckenefick (talk|edits) said:

9 October 2013
I'm more worried about the *separate* issue of my client busting that S-election and what, legally, the a-hole could do to her in a court of law as a result of it.

This is the $64,000 question. Can a minority shareholder bust an S-election without any *civil* repercussions? I realize this isn't a tax question, but I need an answer...

Death&Taxes (talk|edits) said:

9 October 2013
Yes, she is a shareholder but she is also an investor. Investors like Carl Icahn are always breaking chops and not getting sued. I realize these are publicly traded companies, but corporate status is the same whether big or little. She might find some smart lawyer to put forth the idea that S Status is not the best for this company (of course, with demands for financial statements etc).

Ckenefick (talk|edits) said:

9 October 2013
http://www.shareholderoppression.com/newjersey-sery.html

What do you think about this?

I came across it just a few minutes ago...

Death&Taxes (talk|edits) said:

9 October 2013
The New Jersey case is up in the air for now, but with Massachusetts courts seeing it one way, and courts in Kansas and California the other, it shows the need for a lock-tight shareholder agreement on joining the ranks. Even there, where there is a procedure for selling shares to the other holders, what happens if no one will buy? Usually this is spelled out, but if outside shareholder MUST sign 2553 and does not want to do so (for the reasons given by the HR), would this be essentially giving a shareholder rights that were severely constrained.

Where is the Georgia lawyer with the many aliases when you really need him?

Ckenefick (talk|edits) said:

9 October 2013
Probably in the courtroom with a shareholder "oppression" suit...

Gazoo (talk|edits) said:

9 October 2013
Well, I don't know all the concepts and law and the violations like you guys do, but I'd have her see a lawyer, maybe a corporate dervative action would be appropriate, or she could ask that a receiver be appointed, or both, or a lot of other things. It is rare that a judge would appoint a receiver, however, it does happen, but nevertheless you'd add the count as a shot over the bow.

Ckenefick (talk|edits) said:

9 October 2013
It would be really cool if you got someone like Jerry Rice.

NMexEA (talk|edits) said:

9 October 2013
Gazoo, I was thinking the same thing, a shareholder derivative action. I like the idea, though, of transferring the shares to an unqualified shareholder to end S-Corp status.

Ckenefick (talk|edits) said:

9 October 2013
http://www.cchgroup.com/opencms/opencms/web/TAA/PDFs/focus-on-tax-newsletter/JPTE_14-02_Walthall.pdf

Ckenefick (talk|edits) said:

9 October 2013
She might find some smart lawyer to put forth the idea that S Status is not the best for this company (of course, with demands for financial statements etc).

To that point, seems that in some states, there is no fiduciary duty to the other shareholders. As such, no reason needs to be given. In fact, you could probably walk into court and say, "I acted selfishly and vindictively, so what. There's no fiduciary duty. Furthermore, this could have been avoided with proper documentation and a buy/sell, etc. in place. Majority shareholder chose not to do that. That's on him. No different than someone dying without a will."

But, if for some reason you did have to give a reason, I think a real good one would be: "I asked to see the books and was denied. I do not trust the majority shareholder's bookkeeping and I certainly would not trust the numbers that show up on my K1 every year. Given these issues, I had to put an end to the K1 reporting."

To join in on this discussion, you must first log in.
Personal tools