1120S Sale

[Tam01]

Hi Everyone!

I have an S-Corp which sold with a contract date of 1/1/23. The stock was transferred as of 1/1/23.

The single shareholder has distributions in excess of basis which were classified as shareholder loans receivable, as the intent was to offset future S-Corp earnings until the AAA account was positive, but this did not happen.  There is NBV of fixed assets $15k, SH Loan Rec $135k and a SBA loan payable $150k.

The single shareholder sold the stock and no other compensation was received. The effective date is 1/1/23.

The new S-corp owners assumed the SBA loan debt which was in the name of the company as well as discharge of shareholder debt.

As I see it, in 2022, the shareholder has to recognize regular income for the shareholder debt - 1099-C.  Form 1120S - no deduction given, but a M-1 adjustment.  This puts the balance sheet all out of whack.  Assets $15k; SBA Loan $150k and Retained Earnings -135k - also I believe this would carry forward to the new company - no step up in basis, etc.  Form 8594 poses an issue...there is no real consideration outside of the stock purchase, thus no sales price allocation?

The shareholder recognizes capital gain income from the monies received as a result of the stock sale.  This becomes outside basis for the new shareholders.

Originally, I was thinking that the sales price would be the $135k of SH debt/excess distributions since it was assumed.  The seller would recognize $135 of capital gain income and the allocation of sales price to assets would include goodwill.  I would still have an issue with the balance sheet.  I don't think it is appropriate to just zero it out.

Any insight you could provide would be greatly appreciated.

[sjrcpa]

The corporation still exits so you do not zero out the balance sheet.

[Tam01]

I agree, I cannot zero out the balance sheet.

The treatment of the negative basis classified as a loan is more of my issue.  In order to bring the AAA to zero it is either a capital gain or treated as loan forgiveness.  I am trying to figure out the proper treatment.  I am leaning toward 1099-C because the monies were never paid back or claimed as capital gains when AAA became negative.

[BobKamman]

I don't see anything happening in 2022.  Seems to me the seller should get a K-1 for the day he owned shares in 2023.  

[qbteachmt]

"This puts the balance sheet all out of whack. Assets $15k; SBA Loan $150k and Retained Earnings -135k"

What is out of whack there?

It was:

Assets $15k (tangible) + $135k (owed from sh) = $150k

Liability $150k (SBA)

Equity = 0

Obviously, he took home most of the SBA loan...

And changed after forgiving the SH loan:

Assets $15k

Liability $150k

Equity -$135k

Because the corporation has a big hole to dig out of. Isn't this what you show?

[Tam01]

Correct...the S-corp has a big hole.  This will take some time to overcome. The stock was sold at $24k which is a personal capital gain to the shareholder.

The -137k AAA.  How does that get taxed to the old shareholder?  I am struggling as reporting it as an excess distributions (capital gain) or a cancellation of debt.  Feeling like it is cancellation of debt. 

The new shareholders will have a negative RE and if I am thinking about it correctly, will have basis issues for a few years and not be able to draw out any monies without capital gain implications. The company generates a bit of cash flow.  

Form 8594 requires me to allocated purchase price between assets.  The purchase price was $24k for the stock and no other monies received.  I guess I would use the 24k and allocate between the classes of assets.

[sjrcpa]

New shareholders' basis = $24K on 1/1/23.

In your opening post you said the new shareholders forgave the debt. Now you're questioning/debating that. What does the stock purchase agreement say?

How does Form 8824 come into play? What like kind exchange?

[qbteachmt]

"The purchase price was $24k for the stock and no other monies received. I guess I would use the 24k and allocate between the classes of assets."

The entity's holdings didn't change when the stock sold. The entity did not sell its assets. Don't confuse the entity and the individual that was a shareholder.

If I sell you my GM stock, there is nothing that happens to GM.

[Tam01]

The form is 8594 - asset acquisition statement, I put the wrong form number on my original post.

The interest in the LLC (treated as an s-corp) was sold.  The language of the agreement is as follows:  The purchasers unconditionally assumes and agrees to pay, perform, discharge and satisfy and and all liabilities of the company.  There are no monetary values listed in the contract.

I am struggling with a couple of issues: 

1) The outgoing shareholder has a negative basis which was classified as shareholder loans in order to balance the balance sheet.  The shareholder never made whole on the basis issue.

2) Is the correct treatment for the old shareholder to claim the $135k as income through a 1099C?  Does this mean the new shareholders should be able to have an outside basis of $135k to offset the negative retained earnings? Or claim 135k as the sales price + 24k in stock and allocate the $135k as non-deductible goodwill (or to really offset the negative retained earnings).

3) How do the new shareholders overcome the negative retained earnings.It seems like they will be taxed on distributions unless $135k of earnings is retained in the company at all times.

[sjrcpa]

Why do you need an 8594 for a stock sale?

Pre-purchase negative retained earnings has no basis effect on new shareholders.

[qbteachmt]

"The interest in the LLC (treated as an s-corp) was sold."

You had a sole shareholder. Are you trying to describe that the S Corp is closed down and fell back to an LLC (State construct, single-member = sole proprietorship) existed for the sale? And now they are a partnership; or, still that same EIN S corp? Stock sale = entity did not change.

"The language of the agreement is as follows: The purchasers unconditionally assumes and agrees to pay, perform, discharge and satisfy and and all liabilities of the company. There are no monetary values listed in the contract."

Money in the bank has a stated value, so that part is easy. Fixed and intangible assets would have been valued, too, and agreed upon, and documented.

You likely stated it properly here: "The stock was sold at $24k which is a personal capital gain to the shareholder."

Stop trying to apply anything about the entity to that part of these events. That isn't an internal price or valuation for the entity.

For this: "1) The outgoing shareholder has a negative basis which was classified as shareholder loans in order to balance the balance sheet. The shareholder never made whole on the basis issue."

There will be no "making whole" as it is being forgiven, right? What you seem to have is: the distributions were too high, and would either taxable income each year it happened, or treated as a loan to the shareholder/borrower. They got treated as loan to shareholder, to be repaid? Is there a note payable? If not, then the tax year(s) this happened, it would have been taxable. This assumes it is over and above payroll to that person, as well.

"2) Is the correct treatment for the old shareholder to claim the $135k as income through a 1099C?"

Here's where you start to commingle the perspective. The corporate entity issues a 1099-C, as the lender. This is not a basis issue. Think for a minute if the corporation had made a loan to a unrelated individual. They expected to collect on that loan, so that is an asset to the corporation. Then, the borrower proves to be a deadbeat. The lost asset (the funds) is not basis to the borrower. The unrecoverable asset affects equity, to close out the expectation of repayment. That's what happened at the sale, since everyone agreed the loan is not expected to be repaid, and your borrower is no longer a shareholder, and the event is not a basis event. It's a lending event. At least, as you have described it.

"Does this mean the new shareholders should be able to have an outside basis of $135k"

That's not what they paid. If you buy a $150k house for $15k, your basis is $15k.

"to offset the negative retained earnings?"

As they pay off debt, that will remove the liability. As they operate at a profit, that will increase RE, too.

"Or claim 135k as the sales price"

It's liability. They have the SBA debt. It isn't also part of something else. Go back to my first posting, to see it balances.

"3) How do the new shareholders overcome the negative retained earnings."

Work it, baby!

Someone else will contribute, too, and let me know if I got something not quite right (I'm in a bit of a rush today). Hope this helps.

[BobKamman]

I don't know how anyone can answer these questions without having copies of the last few years' returns to review.  But I still don't think anything happened to affect the 1120-S.  And I still see it happening in 2023, so finish the 2022 return and let the buyer sort out 2023.  What was the point of having a 1/1/23 closing date, if not to throw the sale into the new year?  And KISS -- what did the seller get?  Cash, and the buyer assumed the SBA loan?  So add those two together, and if it's $135K, then report it on the 2023 return.  Certainly the SBA lender is not going to be canceling any loans, so put 1095-C out of your mind.  

There are two loans here, the SBA loan and the company loan to the selling shareholder.  One might have provoked the other, but they are unrelated.  Certainly the seller shouldn't have to pay tax on the same amount twice.  Neither loan has been paid off as of 12/31/22.  Let the buyer's preparer figure it out next year.