We are four shareholders of a professional S corporation in the United States. Each of us owns 25% of the corporation.

Each shareholder keeps track of his own billable hours, and the corporation bills the clients on a monthly basis. When a client pays for the work performed, the payment is credited to the particular shareholder who performed the work. Since all payments received by the firm are allocated to a particular shareholder, no money actually belongs to the firm as a whole.

Each shareholder is paid a salary, so long as that shareholder maintains a positive balance. A shareholder may, but is not required to, withdraw additional money at any time from his account, which is then run through payroll. A shareholder who has a negative balance is not allowed a salary.

The costs of running the corporation are split evenly (25% each) between the shareholders.

We have a situation in which two of the shareholders have generated a substantial amount of money - and have left that money in the corporation - while the other two have negative balances.

Our CPA has provided us with Form 1120 Schedule K-1s, which divide the firm's balance evenly between the four shareholders (Schedule K-1, Part 1, line 1). The balance actually belongs to the two profitable shareholders; the two shareholders with negative balances do not own any part of that money, and will not receive any part of it. However, based upon the K-1s issued, those two shareholders with negative balances would still have to pay taxes on their reported fourth of the balance.

Question 1: Was the CPA correct in simply dividing the balance equally, or should the CPA have prepared different K-1s showing how much of that balance actually belongs to each individual shareholder?

Question 2: If the balances are to be divided equally, is there someone else that the two shareholders with negative balances can account for their lack of share in the income?

Any help greatly appreciated.

Thank you.