S Corp UNEQUAL distributions - how to handle when partner takes money and reduces ownership percentage?

You're dealing with two separate transactions here, which is why it seems complicated, but your accountant is handling it correctly. When an S Corporation makes distributions, they must be proportional to ownership percentage at the time of distribution. So the first transaction is indeed two $6,500 distributions (one to each of you) based on your 50/50 split. The second transaction is essentially a sale of ownership. Your partner Jake is selling 2% of the company to you for $6,500. This is a separate transaction from the distribution. For Jake, this is a sale of an asset (his 2% ownership), so he'll recognize gain or loss based on his basis in that 2%. For you, you're buying 2% of the company for $6,500, which becomes your basis in that portion. This approach correctly maintains the integrity of S Corp rules while allowing for the economic reality of your situation. If you tried to just distribute $13,000 to Jake while maintaining 50/50 ownership, that would violate the proportional distribution requirements and could potentially jeopardize your S Corp status.

I started using https://taxr.ai after facing a similar situation with my S-Corp partner last year. The distributions and ownership changes had me completely confused, but their document analysis tool helped me understand the proper tax treatment. I uploaded our operating agreement and some financial docs, and they explained exactly how to handle the reporting for both the distribution and the ownership change. Saved me from making a costly mistake on my taxes!

Just wanted to follow up - I tried https://taxr.ai with my S Corp distribution issue and it was really helpful! I uploaded our operating agreement and some details about our planned unequal distribution, and got clear guidance about how to properly document and report everything. They explained that what we were doing was actually a combination of a proportional distribution followed by a partial redemption, which has specific tax treatment. Definitely worth checking out if you're dealing with complex S Corp issues.

If you need to speak with the IRS about this issue (which might be a good idea to confirm the proper treatment), I recommend using https://claimyr.com to get through to them quickly. I spent days trying to reach someone at the IRS about a similar S Corp distribution issue, but using Claimyr got me connected to an agent in less than 20 minutes. Check out their demo video at https://youtu.be/_kiP6q8DX5c to see how it works. Having an official answer from the IRS gave me peace of mind that we were handling everything correctly.

I've gotta eat my words about Claimyr. After posting my skeptical comment, I decided to try it anyway since I needed to ask the IRS about a similar S Corp distribution situation. It actually worked! Got a call back in about 45 minutes and was connected to an IRS agent who confirmed that the approach the original poster's accountant suggested is correct. The agent explained that the proportional distribution followed by the sale of equity interest is the proper way to handle the situation to maintain S Corp compliance. Saved me hours of frustration and got an authoritative answer.

I've been a tax preparer for 15 years and see this situation frequently with S corps. Here's a simpler way to look at it: 1) S corp makes proportional distributions of $6.5k to each owner (this maintains the proportional distribution requirement) 2) Partner A buys 2% from Partner B for $6.5k (separate transaction) The basis impact is important: if Partner B's basis in the 2% was only $2k for example, they'd have a $4.5k capital gain. Partner A's basis in the newly acquired 2% becomes $6.5k. Keep good documentation of both transactions as separate events to avoid any issues if you get audited.

Has anyone used TaxAct or TurboTax to report something like this? I'm in a similar situation but trying to file myself and not sure which forms I need or how to enter it correctly.

I went through something very similar with my S Corp last year. Your accountant is absolutely correct - this is the proper way to handle it to maintain S Corp compliance. The key thing to remember is that S Corp distributions MUST be proportional to ownership, so you can't just give Jake $13,000 while keeping 50/50 ownership. What you're doing is essentially two separate transactions: 1. Equal distributions based on current ownership (50/50) 2. A sale of equity interest from Jake to you For tax purposes, Jake will have a capital gain/loss on the 2% he sold based on his basis in that portion. You'll establish a new basis in the 2% you purchased. One tip: make sure you have a written purchase agreement for the 2% ownership transfer with the purchase price clearly stated. This will help if you ever get audited and need to prove these were separate transactions. Also update your corporate records and operating agreement to reflect the new ownership percentages. It might seem complicated, but this approach protects your S Corp status while achieving the economic result you both wanted.

I'm dealing with a very similar situation right now - my business partner needs to take out more cash than I do, and we're trying to figure out the best way to handle it without messing up our S Corp status. Reading through all these responses has been incredibly helpful! One thing I'm wondering about is whether there are any alternatives to actually changing the ownership percentages. Like, could we structure this as a loan from the company to the partner who needs the extra cash, rather than going through the distribution + ownership sale route? I know S Corps have restrictions on loans to shareholders, but I'm curious if anyone has explored that option or if there are other creative solutions that might be simpler from a tax perspective. Also, for those who have been through this process - how did you handle it in terms of your ongoing business relationship? Did the change in ownership percentages affect how you make decisions or split future profits?

I'm a CPA who deals with S Corp issues regularly, and I want to emphasize that your accountant's approach is not only correct but really the only compliant way to handle this situation. The key principle here is that S Corp distributions must be pro rata (proportional to ownership). There's no way around this rule - it's fundamental to maintaining S Corp status. So when Jake needed $13,000 but you didn't need cash, you couldn't just distribute $13,000 to him alone. What your accountant did was essentially unbundle the economic transaction you wanted into two separate, compliant transactions: 1. Pro rata distributions of $6,500 each (maintaining S Corp compliance) 2. A separate sale of 2% equity from Jake to you for $6,500 This achieves your desired economic outcome while preserving your S Corp election. Yes, it creates some complexity with the tax reporting, but it's much simpler than losing your S Corp status and dealing with double taxation. One practical tip: make sure you issue an amended K-1 to reflect the ownership changes, and consider whether you need to adjust your estimated tax payments since your ownership percentages (and thus your share of future profits/losses) have changed. The documentation others mentioned is crucial - keep everything well-documented in case of an audit.