S-Election - Shareholder has negative basis when converting

[lefty88]

Please help!

2 partners in an LLC (Partnership) in 2020.  During year, Partner A buys out Partner B.  At end of year, Partner A has negative $100K in capital account.  Partner B has $0 obviously.

Day 1 of 2021, Partner A makes an S-election.  How should the negative $100K be treated?  

Fwiw: 2021 net income was $215,000.

Really stumped by this!

[lefty88]

FWIW - I have this currently presented on the balance sheet as a -100,000 Adjustment to Shareholders Equity on the line below Retained Earnings (where the 1st year net income is presented)

[sjrcpa]

They don't have negative basis. There's no such thing.

A negative capital account is different.

Did Partner B's capital account get transferred to Partner A at the time of the buyout? And it's still negative?

[rbynaker]

Sounds like there's a lot going on so you need to step through the transactions one at a time.  When A bought out B in 2020 there likely ceased to be a partnership (unless there's something you're not telling us).  While there are no technical terminations anymore, it sounds like this was an actual termination of the partnership when there ceased to be more than one partner.

Once you figure that out, figure out what the remaining owner purchased.  Were assets undervalued?  Were there intangibles?

Then when the disregarded-entity (single-member LLC) elects to be treated as an S Corp it's a contribution of assets to the S Corp from the owner.

[lefty88]

Sorry - brain complete spaghetti on 9/15.  (Actually shocked how poorly written this is LOL)

Try again:

Partner A and Partner B both have negative capital accounts of $50,000 on 12/31/2020.  

Partner A buys out Partner B by assuming his $50,000 negative capital account, AND 

The entity issued a note to Partner B for $200,000 - which was $100,000 for intangible/goodwill (he was the name of the business) and $100,000 for 50% of the machinery and equipment.

On 1/1/2021 the LLC makes an S-Election.  The balance sheet has $200K machinery.  $200K note to Partner B.  $100,000 credit card debt.  

How is the negative $100K (Partner A's capital account at end of 2020) presented on the balance sheet?

[sjrcpa]

Bad move. When you incorporate, excess liabilities are taxable. An LLC making an S election is incorporating for tax purposes.

But, maybe the post closing Balance Sheet should reflect the cost of the goodwill, too. You'll still be upside down though.