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Federal tax law permits the owners of the entity to agree how the income of the entity will be allocated among them, but requires that this allocation reflect the economic reality of their business arrangement, as tested under complicated rules.

While Subchapter K is a relatively small area of the Internal Revenue Code, it is as comprehensive as any other area of business taxation.

So how tolerant is Congress and the IRS when a disproportionate distribution is made but the underlying stock confers identical rights upon the shareholders? S distributes ,000 to A in the current year, but does not distribute ,000 to B until one year later.

Aggregate and Entity Concept The Federal income taxation of partners and partnerships is set forth under Subchapter K covering Sections 701–777 of the Code.

Subchapter K represents a blending of the Aggregate and Entity concepts.

Stated in a more simple manner, a disproportionate distribution will not be treated as creating a second class of stock, provided the underlying stock provides both A and B with identical to the distribution, despite the fact that a distribution happened to be made disproportionately.

That being said, in order to avoid jeopardizing its S election, the corporation would be well advised to make a corrective distribution (even though that distribution will also be disproportionate) as soon as possible.

Aggregate Concept An aggregate concept looks at a partnership as a collection of partners and treats each partner as if he owned an undivided interest in the partnership assets and its operations.