any stockholder of an S-corp or C-corp can be paid dividends even if they are not employees. there is one caveat. the payments must be in portion to the stock holdings. so if shareholder A holds 100 shares and is paid a dividend of $50 every other shareholder must be paid the same 50 cents per share dividend. it is crucial on an S-corp. paying different amounts to different shareholders that are not in proportion to shareholdings would indicate there is a second class of stock which would result in termination of S-Corp status. An S-corp can have multiple classes of stock with strict limitations. every class must have the same rights to distributions and liquidation proceeds.
Treasury Regulations (“Regulation”) § 1.1361-1(l) provides rules interpreting the one class of stock requirement. In general, a corporation does not have an impermissible class of stock if all of its outstanding shares of stock confer identical rights to distribution and liquidation proceeds (“Proportionate Distributions”). However, as mentioned above, the foregoing does not preclude differences in voting and other rights between outstanding shares of stock. As long as the Proportionate Distributions standard is satisfied, a corporation may have voting and nonvoting shares of stock, a class of stock that may vote only on certain issues, irrevocable proxy agreements, or groups of shares that differ with respect to rights to elect members of the board of directors (or managers in the case of a limited liability company).
there are also state laws that may cause legal issues with nonproportional distributions. in one case a C-Corp wanted to liquidate. it was found that some shareholders were paid but others were not. it could not liquidate until it paid those unpaid dividends to the proper shareholders. to those, it could not find the amount unpaid had to be turned over to the state to hold (escheat) as unclaimed property. this was very expensive for the corp because the non-payments went back about 20 years. so the records for those years had to be obtained and then the numbers reconciled.
as to what the IRS could do with disproportionate distributions is take the position that the proportionate amounts were dividends but anything else was compensation and then it hits the corp for unpaid payroll taxes, penalties and interest. this could be done to either a C or S-corp. in addition the IRS would change the S to a C-corp and then all its income is subject to income taxes.
Does an officer of a corporation have to report all compensation for payroll tax purposes? it depends on how you define compensation. salary - yes, reimbursement under an accountable plan - no, pay officer's personal expenses that are expensed on corp books - yes. what if set up as a loan - well then the officer should pay back promptly. nonpayment, if caught by the IRS, could be deemed compensation. dividends - no but it could be compensation if disproportionate. on a S-corp any medical insurance paid by the Corp for a s/h or s/h family holding more than 2% of stock must be added to the W-2. if not it's a non-deductible expense.
if a shareholder performs no services for the Corp then they are not an employee.
