Please help, I have an 1120-MESS

[frencheese]

I had a disaster file dropped in my lap yesterday and I don't know what to do with it. This was my first tax season and I mostly worked on 1040's.

Client somehow at some point previous to 2013 contributed farmland to an 1120-S, at least on his books, because it's illegal in my state for a corporation to own farmland. So the farmland is actually in his name only (inherited from his father back in 2008 apparently) even though the 1120-S is 50-50 him and his wife. They sold a portion of the farmland in 2017. My coworker (who no longer works for us) appropriately listed the land sale on client's personal return in 2017. On his books, client lists the land sale in 2018 in the Scorp as what I can only call a contra asset.

It seems to me that the farmland, the section 1250 buildings that are attached to the farmland, the depreciation related to the buildings, and the contra asset "land sale" need to be removed from the books of the Scorp, along with an adjusting entry to retained earnings (Client does not have any equity accounts besides retained earnings and distributions on the books despite a law requiring $1000 in capital stock in this state) I made an entry to to fix the trial balance in Workpapers CS. However, when I go to try to basically remove these assets from the 1120-S, Proseries gets upset with me and doesn't want me to adjust retained earnings and says if I unclick the box to automatically calculate that I will have to enter the K1s manually.

I don't even know how to appropriately remove the assets from the 1120-S, as "Removal of erroneous assets" as a description may not please the IRS. But its not a sale or disposition, the Scorp does not actually own the land its been reporting as an asset since at least 2013. Someone please help me as I have no idea what to do.

MESS NUMBER TWO: Client has loans to two former schedule C LLCS that were administratively dissolved in 2018 listed as assets on the Scorp books for 2018. These loans are included as assets on the 1120-S, starting in at least 2013. If I write off these loans as bad debts and zero out these accounts, is that loan forgiveness and would it need to be reported as income?

Thank you for any assistance you can provide, I am in over my head.

Bree

[George4Tacks]

You did not indicate a product, but I am guessing ProSeries. Let's call @IRonMaN in and see if he can offer any calming words. 

[frencheese]

I have another question regarding the loans to the single-member LLCs from the Scorp. If client is a 50% member of the S-corp and the S-corp makes a loan to his single-member LLCs, is that considered bona fide debt? Because if it's not bona fide debt, apparently I must treat those loans as contributed capital.

[Just-Lisa-Now-]

If this is your first tax season and youve only prepared 1040's, you need to send this person to someone that is experienced in corporation taxes. 

Corporation returns are a whole different ballgame compared to individual returns. 

[frencheese]

I wish I could. I'm supposed to figure this out and then give it to my boss, who is a CPA, to review. I am the only accounting assistant in the office anymore.

[Just-Lisa-Now-]

Ahh, ok, so you do have someone that can assist you in this. This isnt something I would expect a new preparer to tackle on their own!

[IRonMaN]

Out of curiosity, what was the offset on the balance sheet when the land was supposedly transferred into the corporation?

[frencheese]

I have tax returns going back to 2013 and there is no additional paid in capital and only the legal minimum of $1000 in capital stock (that client does not report on his books). I assume that the retained earnings account was used.

[IRonMaN]

When the sale was done in 2017, was the business name or the individual's name of the 1099-S?  Also, did the sale proceeds go into the corporate checkbook or the individual's checkbook?

[sjrcpa]

Are there loan documents for this "loan"? That will determine bona fideness(?). If no, what evidence is there for these loans? 

And how would you get it to contributed capital? Loan receivable from LLCs is an asset (debit).

Maybe distribution from S Corp to owner, who then contributed to SMLLC.  But if only a 50% owner of LLC, distributions would not be pro rata according to ownership.

[frencheese]

The 1099-S is in the name of the client and what was left after paying a mortgage went into the corporate account.

[IRonMaN · Accepted solution]

And the proceeds were entered into the corporation as debit cash credit retained earnings?

You do have a mess.  I would go in and remove the land from the books with an offset to retained earnings based on the story you have told.  I would then attach a friendly note to the return saying that land that was not owned by the corporation was improperly recorded in the corporation and you are now being merciful and backing it out.  If you have to override something to get there, do the override and move on with life.  Is there positive equity left in the corporation after the land removal?

[qbteachmt]

"apparently I must treat those loans as contributed capital."

Do you have money flowing both directions or only one?

I first read this as money loaned to the Sched C businesses, which of course, has no real tracking of Contributed Capital.

If there is money Out of the S Corp for "loans": Since loans between yourself and your own Sched C entity are not "real", their treatment in the S Corp should be treated either as loan to Shareholder or Distribution. You stated there are two shareholders, so two individuals getting K-1. That means Distributions would need to be 50-50, which normally is a problem when people take money like this. That's why the Loan to Shareholder is used, to offset inequitable distributions until this can be resolved. In this case, though, it seems you can offset the loan Out as distribution Out; just split it to the married couple.

For money Into an S Corp, you have to determine if this should be contributed capital or loan To the S Corp, and again, taking into consideration all shareholders. While the S Corp can have a Note Payable to the shareholder(s), I suspect you will be rebalancing all these mistaken values against each other. Until you come out at the end, it's hard to see what will happen with this part.

And you describe the land sale is both 2017 and 2018, so obviously, things are very wrong. The farmland never put in the name of the S Corp means it was never contributed to the S Corp.

"I don't even know how to appropriately remove the assets from the 1120-S, as "Removal of erroneous assets" as a description may not please the IRS. But its not a sale or disposition, the Scorp does not actually own the land its been reporting as an asset since at least 2013. Someone please help me as I have no idea what to do."

Can't you treat the farmland as Leased, and that means some values for asset and depreciation would be appropriate.

[frencheese]

Yes, you're right, it's a capital contribution to the LLCs and I suppose a shareholder distribution from the S-corp as they are single-member LLCs

[frencheese]

Yes, with making the necessary changes and the offset to retained earnings, which I did, after 2018 income is included equity is positive.

On another note, now the client must recognize over $700,000 in income because if I say the loans are loans, then they must be forgiven and income recognized. If I say the loans are not bona fide (which they don't appear to be) that would a shareholder distribution. Can I say they are loan to shareholder and leave them on the books even though the LLCs are dissolved?

[qbteachmt]

"Can I say they are loan to shareholder and leave them on the books even though the LLCs are dissolved?"

Uh, no. For one thing, you likely have a situation where you need imputed interest. Once you work this out, the Loans would be offset as distributions, typically, since you have no need to worry about equitable distribution. Put 50-50 to each spouse.

I use "loan to shareholder" to "park" values while I am trying to sort out what is what. Then resolve and close out anything that won't be repaid or isn't really a loan. A Real Loan has a note payable, has terms, has a true use for the funds, etc.

I mentioned how you are handling the farm land might be recast as Lease, for instance. In that case, the farmland owner has lease payments, and the S corp paid lease payments and did not give the shareholder a loan or a distribution.

You don't need to relate "S corp money out = LLC money in." You relate "S corp money out" to the Person, who then used it for whatever they used it for. Now the issue is, what do you need to categorize that S Corp money out as being paid out for?

[frencheese]

Thank you for your response, it was very helpful.  I am not sure exactly how to do that, but I will figure it out and show your response to my boss.

[frencheese]

Wouldn't the client then have to recognize the lease payments as income? I really don't see any way around recognizing the $700,000 as income.

[qbteachmt]

Well, yes, you would need to sort out what applies and what seems the right decisions. I was simply offering how to handle that the Land was involved in the operations, so there should be some consideration for how the heck they got to use this land. That also addresses the issue of depreciation, if not these values, and the taking of funds, whether for lease payments or as distributions. All of it needs to be laid out as the different scenarios, choosing what really applies. Right now, nothing existing seems to apply. Payroll hasn't even come up in these discussions, yet 🙂