Client Selling Business

[KBTS]

A client has come to me asking for advice/help with the sale of his business. I only do his personal taxes, but he has provided copies of the corporation’s returns for the last three years for my review. Client is unhappy with the accountant who prepares his business return, so that is why he is asking for my help. He was planning to sell the stock of the corporation, which I thought I had pretty much figured out; but now, the plans have changed and he is selling the assets – so I need some help on this.

Here are the details on the sale:

Corporation has rather large NOL from prior years ($50,000). All fixed assets are fully depreciated. Business owes $20,000 to bank on line of credit loan and around $15,000 to client as shareholder loan. He is selling for around $45,000 – with $20,000 down and rest received in installments. Owner plans to use the down payment to pay off the bank loan since buyer will not assume the debt. Basis in stock is $7,000.

Now for my questions:

1. Gain on the sale of fixed assets will first be ordinary income for depreciation recapture and then capital gain for any amount over that, right? If so, will the NOL negate these gains on the final 1120 for the corporation?

2. How much gain on the sale should be reported – the net amount he will receive after paying the bank and his loan minus stock basis (or some other amount)? How will this be handled under the installment sale since he will not get enough cash up front to pay off both amounts?

3. I know form 8594 will need to be filed with the corporation’s return, but does anything else need filed if “final return” is marked on the 1120?

I think that is it for now. Sorry to sound so clueless, but this is the first time I have run across a business sale. If I am in over my head, I will just tell my client this and have the accountant who does his business return handle this.

Thanks

[Bees Knees]

1) A good reason for the seller to sell the assets of the corporation rather than the stock, is that by selling the assets, any gain on the sale is offset by the NOL carry forward. So you are correct in your assumption in question one – ordinary income + capital gain minus NOL.

2) Since we are talking about selling assets inside the business, the bank loan payoff has nothing to do with gain or loss. You simply take your sales price minus cost basis, and there is your gain. Don’t mix the shareholder’s stock basis into the equation until the corporation is liquidated.

As for the installment sales method, that is a reason why he may not want to pay off that bank loan right away. The ordinary income from depreciation recapture is taxable in the year of sale, even if the sale is under the installment method. Reporting a portion of the gain each year under the installment method only applies to the portion of the gain that is a capital gain. And the installment contract is between the buyer and the corporation, not the buyer and the stockholder. So any capital gain the stockholder might receive upon liquidating his stock has nothing to do with the installment sales contract. Capital gain for the installment sales contract is the capital gain the corporation realizes, not the stockholder.

3) Once you are ready to liquidate the corporation after the corporation sells all of its assets, then you file Form 966 within 30 days after the adoption of the plan of dissolution. Basically, the only thing left inside the corporation after it sells its assets is the cash, the debt, and the installment contract. Then you net the three to determine the liquidation proceeds to the shareholder, who then realizes a gain or loss against his stock basis.

[BOB W]

3) Once you are ready to liquidate the corporation after the corporation sells all of its assets, then you file Form 966 within 30 days after the adoption of the plan of dissolution. Basically, the only thing left inside the corporation after it sells its assets is the cash, the debt, and the installment contract. Then you net the three to determine the liquidation proceeds to the shareholder, who then realizes a gain or loss against his stock basis.

It is my understanding that if you dissolve the corporation before the installment note is paid off the full deferred gain becomes taxable. Am I correct????

[KBTS]

A little more help please....

Bees Knees:

Thanks for the response.

It makes more sense now that you pointed out that the installment agreement is between the corporation and buyer - not with the shareholder. That helped out quite a bit. If I am reading your post correctly, after the assets are sold the corporate shell will continue to exist until all installment payments are made? If that is not the case, how does the liquidation occur if the installment agreement is still there?

Would the whole situation be much simpler if the seller could get the buyer to pay the entire amount up front? That way, the corporation would recognize ordinary income and capital gain on fixed assets, capital gain on the amount of goodwill from the sales price - all of which would be wiped out by the NOL. Seller could then pay off bank, repay shareholder loan and then compare remaining cash to stock basis to determine personal gain or loss. Let me know if that sounds right. This whole situation seemed easier when it was a stock sale.

[JON]

Nol

If the gain and the NOL wipe each other out then you could pass the note out in liquidation. If there is any not recognized gain in the corporate installment note it does become taxable when the note is passed out to the stockholders.

[Bees Knees]

A C corporation would recognize gain on the distribution of an installment obligation in a complete liquidation. But under Section 453(h), the shareholder is not treated as receiving the obligation in one lump sum. Rather, as each payment is received, it represents that portion of the liquidation of his or her stock.

So the NOL wipes out the tax on the installment sale on the corporation side when it distributes the obligation to the shareholder, and then the shareholder pays tax as each installment payment is received.

[KBTS]

Bees Knees,

Any chance you could email me about this? Client wants answer early next week. Thanks - Kirk