James J. Maggard & Szu-Yi Chang, 3965-20

Background

James Maggard co-founded Schricker Engineering Group, later incorporated as an S corporation in California with a single class of 10,000 common shares.
Maggard sold controlling interest to two friends (LL and WJ), but remained a 40% shareholder; the governing documents were never amended to allow for unequal distribution rights.
LL and WJ took unauthorized, disproportionate distributions and denied Maggard his share of profits, eventually freezing him out of management and board roles.
State court found that LL and WJ misappropriated profits and ordered a corrective distribution to Maggard, which was not paid; Maggard sold his stake in settlement.
Maggard self-prepared income tax returns based on incomplete information provided by LL, who did not timely file S corporation forms or issue K–1s, leading to IRS adjustments and audits for 2014–16.
Maggard argued the misconduct should have terminated Schricker’s S corporation status, excusing him from pass-through taxation on income he never received.

Issues

Issue	Plaintiff's Argument	Defendant's Argument	Held
Does unauthorized disproportionate distribution of earnings terminate S corporation status?	Schricker’s status as an S corp was terminated by the unequal, unauthorized distributions in violation of proportional rights.	S corp status depends on the governing documents, not shareholders’ conduct; unauthorized distributions alone don’t create multiple classes of stock.	Disproportionate payments did not alter corporate documents or violate one-class stock requirement; S corp status continued.
Should Maggard be taxed on income he did not actually receive due to misconduct by co-owners?	He should not be required to report/ pay tax on income not actually distributed to him.	S corp shareholders must report their pro rata share of income, regardless of distributions actually received.	Maggard is taxed on his pro rata share whether or not he received distributions.
Does lack of information and K-1s from Schricker excuse Maggard from reporting S corp income accurately?	Lack of K–1s and info should relieve him from liability for incorrect reporting.	Shareholders have reporting obligations regardless; company’s delay does not excuse errors.	Maggard is responsible for accurate reporting; discrepancies result in IRS adjustments.
Does state court’s finding of misconduct require reclassification of Schricker to a C corp for tax purposes?	Yes, the court-acknowledged wrongful conduct should mandate C corp status.	No, unless formal governing documents are changed, S status remains intact regardless of wrongful conduct.	State court findings do not alter S corp status for federal tax purposes.

Key Cases Cited

Mourad v. Commissioner, 387 F.3d 27 (1st Cir. 2004) (S corp election remains effective absent revocation or termination)
Schulz v. Commissioner, 294 F.2d 52 (9th Cir. 1961) (conduct unless memorialized in governing documents does not affect S corp status)