My client is 100% owner of S-corp in PA. effective 1-1-18 he transferred 49% to his son for $10.company has been valued at $3M.where and how do i report such transaction?

[olga]

Please help me understand what i need to do in this situation. my client is 100% owner of S-corp in PA. effective 1-1-18 he transferred 49% of the company to his son for $10. prior to the transfer, the company has been valued at $3M. where and how do i report such transaction?

they have all corporate paperwork on file. i am working on their 1120S. i understand i will have 2 Sch K-1's listed with respective percentages. but is there anything else i need to report? 

[sjrcpa · Accepted solution]

Father needs to file a gift tax return.

[sjrcpa]

Son's basis in stock = 49% of father's basis immediately before transaction. Father may not claim a loss on the sale/gift.

[rbynaker]

And woohoo, congratulations, now you get no step up in basis on those shares if/when something happens to Dad.  Next you should transfer all of the real estate into the S Corp... </s>

[olga]

@sjrcpa thank you very much for your quick response. so for the purpose of filing a Gift tax return, i will state: 49 shares times $30K each less $10 as the gift value?

on company's Balance Sheet i would assign 49% of Father's equity to Son as of 1-1-18. Father's basis was only $10K as he was distributing most of the profits.  does it make a difference? do i need to make adjustments to the basis to account for valuated share price?

does Son need to report an acquisition of shares on his tax return anywhere? or just K-1 is all he needs?

should Son have filed election of section 83(b)? how would this have worked for him?


@rbynaker i sense sarcasm in your message. what should they have done differently? is there anything they can do now to remedy this situation?

i appreciate your time and help. i am new in this area and your expertise is invaluable to me.

[sjrcpa]

The gift is FMV less $10. Son's initial basis in the syock is $10 + 49% of father's basis.

In the S Corp, enter the change of ownership -dates and percents so the K-1s show income/loss on a per share per day basis. Read the gift tax return instructions - you'll probably be attaching the valuation report.

On the Balance Sheet there is only 1 equity account.

Too late for 83(b) election and probably not applicable. Below market transfers between family members reek of gift..

Son has no reporting due to acquiring shares.

[olga]

@sjrcpa can Mother consent to splitting the gift and file hew own form 709 to account for half of the gifted amount? is this allowed even though she doesnt own any shares in the S  Corp?

i have so many more questions. is it possible to reach you by phone to discuss more effectively?

[sjrcpa]

Yes father and mother can elect to split the gift.
I volunteer here online but don't do phone comnsults.
File an extension for the gift tax return and deal with it after April 15.

[olga]

@sjrcpa is there a scenario in which it is not recommended to do the split gift tax form?

Son gave Father $10 cash the day they signed the transfer deal so $10 never made it to the books. how should i record it on the books and in 1120S?

the S Corporation initially started with 100 shares at $1 each. i have $100 in Capital Stock account. do i need  to change it now to reflect the recent valuation and the transfer of ownership?

[sjrcpa]

If one spouse has used their lifetime exemption or plans to use it, that spouse would not want to gift split.
The $10 does not belong on the corporate books.
No, you still have 100 shares at $1 each. There are just different owners.

[olga]

@sjrcpa please help me understand the basis vs equity difference. their books are kept as tax books. before the transfer, Father's basis was initial Capital Stock of $100 plus all net profits (or losses) from the date of incorporation, plus Additional Paid-In Capital, less non-deductible items (charity, section 179, life insurance premiums, 50% meals etc), less distributions. so at any given moment i could say Father's basis is equal to Total Equity on S-Corp Balance Sheet. is that correct?  

Now beginning 1-1-18 this is no longer the case, because Son's basis is now $10 + 49% of what was Father's basis as of 12-31-17 but $10 isnt on the books. so Father and Son now need to maintain a spreadsheet with their basis that will only include their own distributions and 51/49% of net profits and other non-deductible expenses.
what i see in Total Equity on the Balance Sheet is not just the sum of Father's and Son's basis anymore nor is the equity proportionally split 51/49 because they did not take same % of distributions, is that right?

and another question: if Father had Additional Paid-In Capital in S Corp before the transfer, does it mean that Son is now entitled to 49% of that? APIC was included in Basis calculation, so i am assuming the answer is yes, but want to double check. should the S-corp repay it back to Father and Son proportionally or does it not matter if its on the books? they have enough basis after 2018 profits to withdraw it (or simply reclassify it on BS??)

thank you so much. I appreciate all of the help, you have no idea...

[sjrcpa]

Equity on the S Corp Balance Sheet is not affected by stock transactions outside of the corporation. Yes father and son should each keep track of their basis in the S Corp. APIC belongs to the corporation, not the shareholders. APIC does not change for changes in ownership occurring outside of the corporation nor for distributions.

[itonewbie]

@olga §83(b) is not applicable since the transfer is not in connection with the performance of service and the stocks are not subject to SROF.

[qbteachmt]

"please help me understand the basis vs equity difference. their books are kept as tax books. before the transfer, Father's basis was initial Capital Stock of $100 plus all net profits (or losses) from the date of incorporation, plus Additional Paid-In Capital, less non-deductible items (charity, section 179, life insurance premiums, 50% meals etc), less distributions. so at any given moment i could say Father's basis is equal to Total Equity on S-Corp Balance Sheet. is that correct?"

Nothing changed for the Corporation. You are confusing the number of shareholders and their proportional split, with the Corporation's financial perspective. You only changed Number of Shareholders and now there is a Split for purposes of the K-1. Let's try this example, Olga:

If I own 5 shares of Ford Stock, the Ford bookkeeping doesn't reflect my personal ownership, because it doesn't affect Ford Corp's financial position. If I decide to sell those 5 shares to you, or only 3 of them, nothing changed for Ford's financial perspective and they do not put this into their financial records. That's why nothing about that $10, or basis or equity, has changed for the corporate books.

Olga asked: "what should they have done differently?"

Ownership has changed, for purposes of the tax reporting to the Shareholders, on the K-1, and one shareholder just Sold some of their shares. But unfortunately, by gifting 49%, the father bypassed what could have been a Step Up in basis. If the father had put the shares into a will or trust as transferring to the son on death, the Son would get that basis as of the date of Death. See how that is a better financial transaction for both parties?

[olga]

@qbteachmt thank you. this is very helpful. if Father would have sold 49% of his shares to his Son or a third party for FMV of $30K per share, what would his capital gain have been and where would he report it ? i would need to know his basis in the company. would it be 49% of his original $1 per share Capital Stock plus all income/losses minus distributions? at the end of 2017 his basis according to books and K-1's was only $10K.  
so would this math be correct:
sale price (49 X $30,000)=$1,470,000
Basis $10,000
Gain $1,470,000 - ($49 capital stock + 0.49 * $10,000 profits less distributions) = $1,465,051?

What would Son's basis be in a year or two should he decide to sell his shares? say S corp had profits of $100,000 both years and Son didnt take distributions. would this be correct math?
Sales price (49 X $30,000) = $1,470,000
Basis $10 what he paid to his Father for a gift +$4,900 assumed Father's basis + 2 x $49,000 2 years of S corp profits = $102,910
Gain $1,470,000- $102,910 = $1,367,090

where do you guys learn all this? it was not in any of my textbooks...

[qbteachmt]

"where do you guys learn all this?"

I'm not a CPA; I lurk here and learn from the others. I consult with small businesses and other entities, and I teach QuickBooks, which means I need to understand how these things should be tracked, which means I need to understand what is done from the beginning and what are the options and impacts and considerations. One of the CPAs here is better able to address hypothetical basis and gain as per your examples.

As for this (instead of an outright sale to start with): "What would Son's basis be in a year or two should he decide to sell his shares?"

From the perspective of what they actually did, you have the answer right in your topic, above, which is why I read these topics and how I learn about these subjects:
Son's basis in stock = 49% of father's basis immediately before transaction. <== sjrcpa

Because that is a gift of Basis minus $10. Again, as provided by sjrcpa:
The gift is FMV less $10. Son's initial basis in the stock is $10 + 49% of father's basis.

Because of the way they did this activity.

"it was not in any of my textbooks..."

"was" never matters. Textbooks are not a useful reference, after printing date. "Now" is what matters. You know the tax regulations changed with the Dec 2017 TCJA, and they often are changed. You have to stay current in your field. People are relying on your guidance and your tasks affect them.