Family businesses often unintentionally violate rules designed to protect shareholders and creditors. This can be a costly mistake. For example, when stock is transferred to children, the majority shareholder(s) has or have a fiduciary duty to the minority shareholder(s). This means, for example, that distributions cannot be made to the majority shareholder without making proportionate distributions to the minority shareholders. Distributions are different than compensation. However, even compensation must not vary too much from industry standards. Similar responsibilities exist to creditors, which generally don’t become an issue unless the business begins to have financial problems or is sued and someone wants to pierce the corporate veil.
Proportionate distributions mean that if one shareholder is paid, for example, $10,000 as a distribution, as opposed to as compensation, and that shareholder owns 50% of the corporation, the other shareholders must also be paid $10,000 divided among them in proportion to their ownership interests. If there were two other shareholders who each owned 25% of the stock, they would each be entitled to $5000. Limited liability companies do not need to make proportionate distributions unless their Operating Agreement requires it. Violation of the law can result in large tax penalties.
If you have been violating this rule, get legal or accounting advice about how to address the situation. Keep in mind, even payments by the corporation on behalf of a shareholder, for example, for life insurance, may be considered a distribution. If it is not treated as a distribution, proceeds may be taxable.