Opinion ID: 2543667
Heading Depth: 1
Heading Rank: 2

Heading: Taxation and Income of Subshapter S Corporations.

Text: The tax treatment of corporate distributions is controlled by state law. K.S.A. 79-32,139, which governs taxation of Subchapter S corporate income, states: A corporation having an election in effect under subchapter S of the internal revenue code shall not be subject to the Kansas income tax on corporations, and the shareholders of such corporation shall include in their taxable incomes their proportionate part of such corporation's federal taxable income, subject to the modifications as set forth in K.S.A. 79-32,117, and amendments thereto, in the same manner and to the same extent as provided by the internal revenue code. Although a Subchapter S corporation may distribute income, it is not required to do so. Thomas v. Thomas, 738 S.W.2d 342, 344 (Tex. App. 1987). Earnings are owned by the corporation, not by the shareholders. 738 S.W.2d at 344. Subchapter S corporations may accumulate profits, referred to as retained earnings. Retained earnings are the net sum of a corporation's yearly profits and losses. See Rohrer v. Rohrer, 715 A.2d 463, 464 n.2 (Pa. Super. 1998). Subchapter S status provides an alternate method of taxing a corporation's income. Thomas, 738 S.W.2d at 344. In a Subchapter S corporation, income tax is paid by the shareholders rather than by the corporation itself. Greely Gas Co. v. Kansas Corporation Commission, 15 Kan. App.2d 285, 286, 807 P.2d 167 (1991) (citing 26 U.S.C. §§ 1361-78 [1988]). When the tax is paid by the individual, the corporation avoids income tax liability. Thomas, 738 S.W.2d at 344 (citing 26 U.S.C. § 1371 et seq. [1982]). A Subchapter S corporation allocates various items of income to shareholders based upon the shareholder's proportionate ownership of stock. Rohrer, 715 A.2d at 464 n.2 (citing, e.g., 26 U.S.C. 163[d][5][A]). Allocations are itemized on an individual shareholder's Schedule K-1. See Miller v. Director, Div. of Taxation, 19 N.J. Tax 522, 528 (2001). Petitioner argues that the district court erred by not including any of respondent's Subchapter S corporations' income or distributions, itemized on his K-1 income tax statements, in calculating child support. Petitioner asserts that the definition of income in the Kansas Child Support Guidelines is so broadly worded that it includes distributions made by Subchapter S corporations to shareholders. She notes that other jurisdictions, when deciding this issue, have not ruled consistently. She points out that several jurisdictions share her concern that a parent might leave assets in a corporation as retained earnings and avoid support because the assets would not be included in the income calculations used for determining child support. See, e.g., Williams v. Williams, 74 Ohio App.3d 838, 843, 600 N.E.2d 739 (1991). Petitioner argues that the district court's ruling was overly broad and that it erred in determining that Subchapter S income is corporate income that is not income of the taxpayer. She concludes that if the district court is correct, the taxpayer would not be required to pay taxes on the income. Although petitioner takes issue with the district court's determination that the distributions were not available for support when the family was intact, she fails to provide meaningful argument on this finding. Finally, petitioner argues that even if the district court is correct in determining that $197,626 of respondent's income was not received for purposes of determining respondent's domestic gross income, the district court should have considered the $70,351 distributed to respondent for the purposes of paying his share of the income tax on the corporations' income. Respondent asserts that because the amounts at issue were never financially available to the family when they were an intact unit, this case is distinguishable from In re Marriage of McPheter, 15 Kan. App.2d 47, 51, 803 P.2d 207 (1990), which determined that a father's Naval Reserve pay relied upon for family expenses during the marriage should be included as income when calculating support. Respondent asserts that because a minority interest holder in a Subchapter S corporation has no ability to control what is distributed, undistributed income is not income for child support purposes. See e.g., Mitts v. Mitts, 39 S.W.3d 142, 148 (Tenn. App. 2000), rev. denied (2001); Fennell v. Fennell, 753 A.2d 866, 868 (Pa. Super. 2000). Respondent also contends that distributions to pay tax obligations should not be included as income. Respondent directs the court to rulings from other jurisdictions that determined that such distributions should not be included when determining support obligations. See, e.g., McHugh v. McHugh, 702 So.2d 639, 642 (Fla. App. 1997). Respondent points out that his children have never received the benefit of the taxable share of income from these Subchapter S corporations. He asserts that the retained earnings are the corporations' income and that there is no evidence that he was manipulating retained earnings to reduce his own income. Respondent addresses petitioner's policy argument that failure to include distributions and income would encourage parents to leave assets in the corporation to avoid support, noting that he has no ability to control the amount distributed to him by these Subchapter S corporations.