No Second Class of Stock

By Schnee, Edward J. | Journal of Accountancy, June 2009 | Go to article overview

No Second Class of Stock


Schnee, Edward J., Journal of Accountancy


The Fifth Circuit Court of Appeals rejected an S corporation owner's argument that the corporation's payments to her father, one of the company's founders, had created a second class of stock that had terminated the S election. The daughter had unsuccessfully sought by that reasoning to exclude from her gross income a distributive share of the corporation's income. The appeals court thus upheld a holding by the Tax Court that there was no proof of any binding agreement that gave the father rights that were not identical to those of other shareholders.

Long's Deferred Products Inc. was incorporated in Louisiana by Julian and Alma Long in 1975 to sell janitorial and paper supplies. The company properly elected to be treated by the IRS as an S corporation. In 1986 the Longs, their daughter, Linda Minton, and their son, Julian "Dooksie" Long, agreed that the parents would receive distributions of $4,000 a month as the children took over the business. In 1990, following Alma's death, the distribution was reduced to $2,000.

By 1996 Linda and Dooksie had acquired complete ownership of the corporation. A dispute arose between them that led to a question of ownership that Linda litigated in state court. As part of this litigation, Linda's attorney determined that the monthly distributions were preferential distributions and not stock purchase payments. The attorney then concluded that the corporation had a second class of stock outstanding and under IRC [section] 1361(b)(1)(D) had ceased in 1986 to be an S corporation. …

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