Dear Tax Guru,

Please help me understand the logic behind the following

Why do the distribution from an S Corporation HAVE to be pro rata? The shareholders are already taxed on their share of the profits . Shouldnt they have a right to withdraw their investment in the proportion they please without having to worry about whether the other shareholders may/maynot want a distribution at the same time? I have been told that it is because uneven distributions would indicate more than one class of shares..but why cant the shareholders withdraw it in the form of return of capital invested instead of a distrbution?

Help!

You have just identified one of the rigid requirements of an S Corporation, in that all distributions have to be pro rata! It is this inflexibility that has resulted in the popularity of LLC's.

No doubt, the S Corporations also has several other advantages over the LLC's, (please refer to my other posts in this Forum) but this rigid requirements have swayed many incorporation decisions in favor of the LLC's.

One of the disadvantages clearly that you have identified has the implication of allocating all distributions along with all profits, credits and section 179 depreciation amounts proportionately to all the shareholders ownership percentages, .

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