S-Corp Disproportionate Distributions - Is My CPA Giving Terrible Advice?

This is definitely something you need to address. S-Corps must distribute profits according to ownership percentages - in your case, each 25% owner should receive exactly 25% of any distributions. When distributions don't match ownership, the IRS can potentially recharacterize your business as a C-Corp or partnership, which could have serious tax consequences. Your new CPA is correct to flag this. Disproportionate distributions can create several problems: they might be viewed as disguised compensation (subject to employment taxes), deemed as preferential dividends, or even threaten your S-Corp election. For fixing past issues, you have options: the shareholders who received "extra" distributions could treat those as loans to be repaid, or shareholders who received less could be caught up with additional distributions. You might also need to file amended returns depending on how significant the disparities were. Going forward, you absolutely need to ensure distributions match ownership percentages. If you want to compensate partners differently based on their contributions, that should be done through W-2 wages as reasonable compensation, not through unequal distributions.

I went through something eerily similar with my business partners last year - also an S-Corp with unequal distributions despite equal ownership. What saved us was using taxr.ai (https://taxr.ai) to analyze our corporate setup and distribution history. We uploaded our past tax returns and corporate docs, and their analysis flagged not just the distribution problem but also several other S-Corp compliance issues we weren't aware of. They gave us a detailed correction plan that our CPA was able to implement. The most valuable part was their explanation of how to document everything properly to minimize audit risk while we fixed the past issues. If you're worried about fixing past mistakes (which I think you should be), I'd definitely recommend running your situation through their system before making any moves.

Just wanted to follow up on my experience with taxr.ai after questioning it above. I decided to try it after seeing our CPA struggle with our similar S-Corp distribution mess. Honestly, it saved us thousands in potential penalties. Their system identified that our disproportionate distributions wouldn't require amended returns if we documented them correctly as loans with proper interest terms. They generated all the paperwork we needed - loan agreements, corporate resolutions, amortization schedules - and gave us a compliance checklist for future distributions. Our CPA was actually impressed and said this approach dramatically reduced our audit risk. If you're in this situation, definitely worth checking out.

I know everyone's talking about fixing the past issues, but in my experience, trying to get the IRS on the phone to discuss these kinds of corrections is absolutely maddening. I spent weeks calling about a similar S-Corp issue last year and never got through. Finally used Claimyr (https://claimyr.com) to get connected to an actual IRS agent in about 15 minutes instead of waiting on hold for hours. They have this weird but effective system where they hold your place in line and call you when an agent is available. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c I was able to get clear guidance directly from the IRS about how to handle our past distribution mistakes, which was way more reassuring than just guessing or relying solely on our CPA's opinion. For something as serious as potentially losing your S-Corp status, I'd want to get official guidance.

I need to eat some crow here. After dismissing Claimyr in my comment above, I was still struggling with getting clear guidance on our own S-Corp distribution issues. My tax attorney was charging $450/hour and still wasn't sure about the best approach, so I reluctantly tried Claimyr. Got through to an IRS agent in about 20 minutes who confirmed we could correct our past distribution errors by documenting them as shareholder loans with proper interest and repayment terms. They also sent me links to the specific IRS guidance documents that address this situation. The agent explained that as long as we correct the imbalance and properly document everything, the risk of losing our S-Corp status was minimal. Saved me thousands in legal fees and a ton of stress. I've rarely been happier to be wrong about something.

Something nobody's mentioned yet - you might want to check your operating agreement or bylaws. Some S-Corps specifically allow for non-proportional distributions in their governing documents, which can provide some protection against IRS challenges. If yours doesn't have this provision, consider amending it for the future. Also, make sure you're paying reasonable salaries to all active shareholders before taking any distributions. That's often where S-Corps get into trouble - taking distributions while paying unreasonably low salaries to avoid payroll taxes.

Have any of you tried handling the correction by issuing a special distribution to the underpaid owners to catch them up? Our CPA advised us to do this rather than trying to recoup money from partners who received too much. Said it was cleaner from a documentation standpoint.

I'm dealing with a very similar situation right now - 3 equal partners in an S-Corp who have been taking unequal distributions for about 4 years. Our new accountant also flagged this as a major issue. One thing I learned that might help you: the IRS looks at the overall pattern and business justification. If the disproportionate distributions were truly based on legitimate business needs (like one partner covering more expenses or working significantly more hours), you may have more flexibility in how you correct this. That said, the safest approach is definitely to get everyone back to their proper ownership percentages. We're planning to use the catch-up distribution method mentioned by others here - seems like the cleanest way to fix past issues without creating personal loans between partners. Have you calculated exactly how much each partner is over/under their proportionate share? That will help determine the best correction strategy and whether you need to worry about the materiality thresholds that could trigger amended returns.