It’s well-established under the Internal Revenue Code that distributions from corporations to shareholders are taxable. However, as shown in a new case, Chernomordikov TC Memo 2025-129, 12/15/25, payouts to other taxpayers may also be subject to tax, including distributions to a shareholder’s family member who also works for the corporation.
Background: Due to a recent tax law change, C corporations pay tax at a flat rate of 21% on their profits. When a corporation subsequently makes distributions to its shareholders—usually in the form of dividends or wages—the payouts are taxable to the recipients. Thus, C corporation income is subject to “double taxation” although this form of business ownership generally provides valuable protection from creditors.
If the corporation pays dividends to shareholder up to the amount of its earnings and profits, the distributions qualify for preferential capital gain tax treatment. Currently, the maximum tax rate for long-term capital gains is 15% or 20% for certain high-income taxpayers. Dividends in excess of earnings and profits are treated as a tax-free return of capital.
Conversely, wages paid to shareholders are taxable at ordinary income rates currently reaching as high as 37%. Plus, wages are subject to payroll taxes.
Different tax rules apply to distributions from other business forms of ownership such as S corporations, partnerships and limited liability companies (LLCs). But these companies are not taxed at the corporate level, so there’s no double taxation.
The taxpayer in the new case used a C corporation’s money like it was coming out of his own pocket. So, it’s not surprising that the IRS intervened.
New case: The taxpayer worked for a company selling electronic devices online. His mother was the sole shareholder of the company. When his stepfather died, the taxpayer assumed some of the operational responsibilities. Previously, his involvement with management was minimal.
Although the taxpayer did not receive any wages from this employment, he used company funds personally. Notably, he bought high-priced luxury vehicles, including as a Lamborghini, a Ferrari, a Rolls Royce, and a Mercedes-Benz. The taxpayer also withdrew cash to pay for other personal expenses. At one point, he tapped the company’s coffers to provide a $1.7 million loan to a friend without documenting a formal loan agreement.
The taxpayer didn’t report any of these distributions as taxable income on his tax returns. Nor did he file any tax returns for the years in question. Accordingly, the Tax Court ruled that he had received taxable distribution from the company, but it didn’t impose fraud penalties due to a lack of evidence.
Lesson to be learned: Owners of small businesses frequently don’t pay attention close attention to the nature of expenditures. It is important to maintain separate business and personal accounts. Help your clients adopt a system that maximizes the financial and tax benefits for their situation.
Photo credit: Samford Cumberland School of Law/Instagram
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