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    S Corp Stock Purchase with S Corp Loan

    An individual (our client) purchased the stock of an S Corp from the lone shareholder of that corp for $450,000. Here's the twist, our client obtained the funds to purchase the stock by obtaining a SBA loan borrowed in the name of the S Corp he is purchasing. The proceeds of the loan were disbursed directly to the previous stockholder. Normally, an individual would obtain his/her own persoanl financing to purchase the stock. In essence, the S Corp has taken on the debt for this personal purchase of the stock. We had not seen this before. We recorded the loan on the balance sheet of the S Corp as a long term liability. Since the S Corp never received the cash from the loan, we put the offsetting debit to a "Due From Shareholder" asset account on the balance sheet. So, we have essentially recorded a loan to the shareholder that we believe the new shareholder is obligated to pay back to the S Corp.

    Are we correct in how we have recorded this on the balance sheet? Is there a better way?

    Is there a danger that the distributed loan proceeds could be classified / must be classified as a shareholder distribution?

    As the S Corp is making monthly payments on the SBA loan, is there any merit to recording an additional monthly journal entry that debits (increases) "Shareholder Distributions" and credits (decreases) "Due From Shareholder" as a way to lower the outstanding due from shareholder balance? The S Corp is profitable and there is adequate stock basis to absorb the distrbutions.

    Any advice would be appreciated. Thank You!
    Last edited by Outlook; 10-09-2006, 11:48 AM.

    #2
    Sounds like this might be a redemption of stock by the S-corp and not a purchase by the new person? cr. loan payable dr. treasury stock. You have to review any documents to see what really happened per the documents. If it is a redemption, then the new shareholder should be issued stock at fair-market-value of the corporation and would owe for the same but not necessarily the amount of the loan. Maybe only issue 1 share for a few dollars. The new person probably has given a person guarantee on the loan which does not give him basis for any loss deduction nor does it create any income to him. I don't see the fact that the loan company/bank paid the old shareholder direct as meaning anything because it would have been at the direction of the corporation.

    Comment


      #3
      Treasury Stock

      I'll be interested in hearing the suggestions on this thread. Hope OutLook doesn't mind me posting this, not trying to take over your thread

      Something similar happened to a customers of mine. S-Corp. was purchased by new shareholders. Old shareholders sold the stock in the company and financed the sale of the stock. New shareholders are paying the note out of the S-Corp. One of the new shareholders has a bachelors in accounting. He asked new CPA if the amounts paid out of S-Corp could be counted as Treasury Stock. CPA said yes at first then said no and counted the first year payouts on the note to the old shareholders as distributions to new shareholders.

      New shareholders are now coming back to me asking the same questions... can the S-Corp buy back the shares as treasury stock? I have found out that it can but not exactly sure how to do it. I can't find a clear cut answer. Although OldJack is leading me in another direction I can research... redemption of the stock.

      Although now I am not sure it could be done since the first year was counted as distributions.

      Comment


        #4
        You need the appropriate paper work

        You can always have a LEVERAGED buyout of any corporation by financing the majority of the purchase through the corporation (treasury stock), but the new stockholders have to cointribute somnething. The new stockholders eat the income income in the S Corp as the Corp pays the loan off. In order for it to work the profits of the corp are used to payoff the loan which usually means you have income without the cash to distribute.

        You also have to have the paperwork to show that was how the buy should be.

        Comment


          #5
          Originally posted by OldJack
          Sounds like this might be a redemption of stock by the S-corp and not a purchase by the new person? cr. loan payable dr. treasury stock. You have to review any documents to see what really happened per the documents. If it is a redemption, then the new shareholder should be issued stock at fair-market-value of the corporation and would owe for the same but not necessarily the amount of the loan. Maybe only issue 1 share for a few dollars. The new person probably has given a person guarantee on the loan which does not give him basis for any loss deduction nor does it create any income to him. I don't see the fact that the loan company/bank paid the old shareholder direct as meaning anything because it would have been at the direction of the corporation.
          OldJack - thanks for the input - from all of the documentation I've seen, the previous owner directly transfered his shares directly to the new owner. I don't believe I see anything indicating a stock buy back by the company and then a separate reissuance by the corp of stock to the new owner - although I do see a new stock certificate in the name of the new owner. So, if it is determined not to be a redemption and is indeed a direct transfer, how would that change your thinking & advice. Thank You - Outlook.

          Comment


            #6
            Its still hard to imagine that the S-corp owes the loan company and this not be a buy-back/redemption. The new shareholder is simply not the one that owes the debt or borrowed the money. Therefore, the fact that the old stock was "directly transfered" may not be the critical point of the transaction. That could simply be an administrative error, as they say follow the money trail. The fact that the new person has a new issue of stock further points to the redemption and the only thing missing here is that he should pay something for the new shares.

            It would appear to me that the new owner intentional did not want to personally purchase the shares as it would have been easier, in most cases, to borrow money personally than as the corporation.

            Comment


              #7
              ************************************************** ************************************************** ****
              An individual (our client) purchased the stock of an S Corp from the lone shareholder of that corp for $450,000. Here's the twist, our client obtained the funds to purchase the stock by obtaining a SBA loan borrowed in the name of the S Corp he is purchasing. The proceeds of the loan were disbursed directly to the previous stockholder. Normally, an individual would obtain his/her own persoanl financing to purchase the stock. In essence, the S Corp has taken on the debt for this personal purchase of the stock. We had not seen this before. We recorded the loan on the balance sheet of the S Corp as a long term liability. Since the S Corp never received the cash from the loan, we put the offsetting debit to a "Due From Shareholder" asset account on the balance sheet. So, we have essentially recorded a loan to the shareholder that we believe the new shareholder is obligated to pay back to the S Corp.

              Are we correct in how we have recorded this on the balance sheet? Is there a better way?

              I SEE NOTHING WRONG HERE

              Is there a danger that the distributed loan proceeds could be classified / must be classified as a shareholder distribution?

              IT MUST BE A SHAREHOLDER DISTRIBUTION.

              As the S Corp is making monthly payments on the SBA loan, is there any merit to recording an additional monthly journal entry that debits (increases) "Shareholder Contributions" and credits (decreases) "Due From Shareholder" as a way to lower the outstanding due from shareholder balance? The S Corp is profitable and there is adequate stock basis to absorb the distrbutions.

              1- SHAREHOLDER CONTRIBUTIONS---NO- DEBIT "SBA LOAN PAYABLE"

              2- AND CREDIT "DUE FROM SHAREHOLDER"

              3- THE ACTUAL CHECK GOES TO "NET PROFIT DISTRIBUTIONS"



              ************************************************** ************************************************** ****
              The payments to the SBA are nothing more Net Profit distributions, but being paid to a third party for the benefit of the new sole shareholder.

              Any interest issues belongs to the shareholder.
              Last edited by BOB W; 10-08-2006, 09:39 PM.
              This post is for discussion purposes only and should be verified with other sources before actual use.

              Many times I post additional info on the post, Click on "message board" for updated content.

              Comment


                #8
                Sounds like a typical situation created by clients and lenders who couldn't care less about tax ramifications. Something the military has an acronym for.

                Comment


                  #9
                  The way this prior owner has been bought-out is a redemption of stock regardless of what we might think otherwise that it should be. Lets look at what appears to be facts:

                  1. The prior owner wanted to sell his stock and not sell assets of the business as evidenced by signing over actual shares.

                  2. The lender agreed to loan money to the S-corp instead of the common way where they prefer to only loan to the individual new shareholder.

                  3. The S-corp was credit worthy or the lender would not have made the loan.

                  4. An S-corp officer would have been "required" to sign authorizing the payment of the proceeds of the loan to the prior shareholder.

                  5. The new shareholder obviously planned and did not want to pay back a loan from personal funds.

                  Comments:

                  1. If this doesn't fit for a redemption of stock, why would you imagine it would not?
                  2. Why would the new owner want to have the debt charged to him personally?
                  3. Why would it be necessary for anything to be charged to the new shareholder when loans owed by the S-corp are paid? Its not the shareholders debt. Loan payments do not reduce profit that the new shareholder must pay tax on.

                  In my opinion, to treat this as anything other than a redemption of stock would be wrong. The S-corp simply purchased its shares in redemption from the prior shareholder and is now issuing new shares to a different owner. Someone knew this was a good way to retire the prior owner and there is nothing wrong with that and how this was done.

                  If you decide to treat this redemption as something else, be sure you make the new owner aware of the tax difference and how you are doing it or it might come back down the road and bit you with a lawsuit.

                  Comment


                    #10
                    Thanks OldJack. Couple of Questions for you.

                    1. As a redemption, then I see the accounting entries as follows:

                    Debit Treasury Stock $450,000
                    Credit Long Term Liability $450,000
                    To record the original redemption of previous owner shares

                    Debit Note - Due From Shareholder $450,000
                    Credit Treasury Stock $450,000
                    To record reissue of shares to new shareholder

                    1. Do you agree with these entries? Do you agree that the new shareholder owes a debt to the S-Corp? Whether the new shareholder financed personally or it happened through a stock redemption/stock reissue - you agree that the new shareholder has a debt to somebody - correct?

                    2. Old Jack - Let's change the scenerio a little. What if the new shareholder's intent is to buy the shares directly from the old shareholder. The new shareholder arranges private financing with the previous shareholder (note) for $200,000 and the S-Corp took out the SBA loan in it's name for the remaining $250,000 and the proceeds of the SBA loan were distributed directly to the old shareholder. Let's say the reason for why the SBA loan was done in the S-Corps name was because the bank felt the S-Corp was more credit worthy than the new shareholder and they wanted to be as close to the assets as possible that would be supporting the loan (as is the case with most bankers).

                    A. In this scenerio, would you agree that we have three possible ways to look disbursement of the SBA Loan Proceeds directly to the old shareholder: either as conpensation, as a draw, or as a note. My guess is that the new shareholder would want it to be a note. If he elects to have be treated as a note then we record as follows: Debit "Note - Due from Shareholder" and Credit "Long Term Liability at the time the loan is recorded. The new shareholder should have a promissory note drawn up with terms between he and the S-Corp to indicate the the new shareholder owes a debt to the company for essentially taking on a loan on his behalf so he could do a personal transction (buy stock of company)?

                    Thank You!

                    Comment


                      #11
                      Originally posted by Outlook
                      Thanks OldJack. Couple of Questions for you.

                      1. As a redemption, then I see the accounting entries as follows:

                      Debit Treasury Stock $450,000
                      Credit Long Term Liability $450,000
                      To record the original redemption of previous owner shares

                      Debit Note - Due From Shareholder $450,000
                      Credit Treasury Stock $450,000
                      To record reissue of shares to new shareholder

                      1. Do you agree with these entries?
                      First let me say that I would probably agree with whatever the "informed" shareholders say their intent and objective was in this transaction. As such I would try to record in a manner to accomplish those shareholders intent.

                      Otherwise, I would agree this is a stock redemption with the 1st transaction recording the purchase of treasury stock and loan. debit treasury stock, credit long-term liability.

                      I would NOT agree that either shareholder purchased the treasury stock (part 2 of your entry) as the S-corp can keep the treasury stock and issue new common stock for a fair-market-value of the corp (such value having been reduced by the debt).


                      Originally posted by Outlook
                      Do you agree that the new shareholder owes a debt to the S-Corp? Whether the new shareholder financed personally or it happened through a stock redemption/stock reissue - you agree that the new shareholder has a debt to somebody - correct?
                      Absolutely not! The new shareholder has not assumed any debt other than the fair-market-value of the number of shares he has received by the new issue of common stock (or if he agrees to take stock as compensation for services).



                      Originally posted by Outlook
                      2. Old Jack - Let's change the scenerio a little. What if the new shareholder's intent is to buy the shares directly from the old shareholder. The new shareholder arranges private financing with the previous shareholder (note) for $200,000 and the S-Corp took out the SBA loan in it's name for the remaining $250,000 and the proceeds of the SBA loan were distributed directly to the old shareholder. Let's say the reason for why the SBA loan was done in the S-Corps name was because the bank felt the S-Corp was more credit worthy than the new shareholder and they wanted to be as close to the assets as possible that would be supporting the loan (as is the case with most bankers).
                      You have to remember that a S-corp is a separate legal entity from its shareholders with the shareholders only agreeing to pay any income taxes of the S-corp income attributes. Would "you" as an individual take on a loan debt for "me" to buy General Motors stock? You would be wanting a note and pledge of my personal assets. The new shareholder has intentionally avoided personal debt although probably a personal guarantee.

                      The main justifiable reason I can think of for the S-corp to agree to assume the SBA loan debt would be that it needs the money to purchase its own stock or to fund non-taxable distributions (AAA account/capital ) to the old shareholder before sale of stock by the S-corp or by the old shareholder.

                      If the S-corp is assuming the loan for its related new shareholder's personal reasons (purchase stock) I would be extremely concerned that such $450,000 would be a taxable fringe benefit or compensation to the new shareholder. True, it could be considered a loan to the new shareholder but why would the new shareholder want that.

                      Originally posted by Outlook
                      A. In this scenerio, would you agree that we have three possible ways to look disbursement of the SBA Loan Proceeds directly to the old shareholder: either as conpensation, as a draw, or as a note. My guess is that the new shareholder would want it to be a note. If he elects to have be treated as a note then we record as follows: Debit "Note - Due from Shareholder" and Credit "Long Term Liability at the time the loan is recorded. The new shareholder should have a promissory note drawn up with terms between he and the S-Corp to indicate the the new shareholder owes a debt to the company for essentially taking on a loan on his behalf so he could do a personal transction (buy stock of company)?
                      Distribution of the SBA loan to the old shareholder could be either of those you mention and also partly for those 3 items plus a redemption of shares. I would bet that the S-corp assets are security for this debt and not the shareholders (although personal guarantee is likely).

                      You should first look at the alternative that is the best for your client and see if that fits the facts and intent of the parties. Stock redemption is a win-win-win.

                      Comment


                        #12
                        OldJack - your reply was: "Absolutely not! The new shareholder has not assumed any debt other than the fair-market-value of the number of shares he has received by the new issue of common stock (or if he agrees to take stock as compensation for services)."

                        Outlook Response: Old Jack - I'm almost there on the stock redemption - but I still need some help. The purchase price was $450,000. Help me understand the entries on the S-Corp books to record a subsequent issue of new stock to the new shareholder. Up to that point, the S-Corp took out the loan to redeem/payoff the previous shareholder. How/where does the new shareholder pay the $450,000 purchase price. They used the bank loan to get money into the hands of the old shareholder. If the new shareholder had the money, he would have paid the old shareholder himself - he does not have it. So when you now get to the point of issueing new shares to the new shareholder, the new shareholder does NOT have the funds to pay for a new stock purchase - so don't you have to record some type of IOU to the company for the new shares giving ownership to the new owner? If you don't require cash (which he did not have) or you don't record some type of debt relating to the issuance of the stock to the new shareholder - then the new shareholder has taken control of a $450,000 asset without giving any consideration (cash or Debt) - he's gotten something for nothing. Please bare with me - I'm sure I'm missing something simple here.

                        ___________

                        Old Jack - Your reply was: "If the S-corp is assuming the loan for its related new shareholder's personal reasons (purchase stock) I would be extremely concerned that such $450,000 would be a taxable fringe benefit or compensation to the new shareholder. True, it could be considered a loan to the new shareholder but why would the new shareholder want that."

                        Outlook Response: OldJack - I really think this is the true intent of all parties involved - the S-Corp taking on the loan was for the conviencence of the new shareholder because he was not capable of obtaining a loan in his name to purchase the company. The bank simply went to the easiest way to secure their funds. To that end, the new shareholder would prefer the recording of a debt because he would not want to the face (or be able to pay) the tax bill if it were declared compensation or a taxable fringe benefit. Any additional thoughts here OldJack?

                        Thank You

                        Comment


                          #13
                          Have you looked at the loan documents? Maybe the Corporation and the shareholder are co-makers on the loan.

                          The shareholder should have been the the purchaser so as to receive a stepped up basis.

                          Comment


                            #14
                            You are maybe hung-up on the "purchase price". First look at it this way. Lets say the old owner is not selling his stock to anyone, he just wants some cash from the S-corp. The S-corp doesn't have any cash so it goes and borrows in order to give some money to the shareholders. Distributions would first be non-taxable upto the amount of the AAA account (prior S-corp earnings say $400,000). Excess distributions would be tax-free return of capital paid-in (say $30,000) and then any excess would be for part (or total say $20,000) redemption of stock which would be taxable less cost basis, if any, to the old shareholder. This is without any new shareholder in the picture. Now if the new shareholder ( was say an officer before the redemption) decides (or prior agreement) to purchase some stock in the S-corp it can be issued for fair-market-value after the redemption. If the net value of the S-corp after the loan is $1, then the new shareholder can purchase 100% of the S-corp shares for $1.

                            Now, looking at it your way that you think the new shareholder owes $450,000 in exchange for common stock** (which gives him stock basis). Ok... that debt to the S-corp might be paid-off (or partly paid) by the S-corp distributing the AAA account tax-free to the new shareholder (no single shareholder owns the AAA account) and the new shareholder paying the same back to the S-corp as reduction of the shareholder debt. You would have to actually write checks to and from to be safe. Then if the S-corp cash will allow further distributions can be made reducing stock basis. The S-corp must hold a written note signed by the new shareholder, such note requiring interest (assuming debt is over $10,000). If S-corp cash available was no problem, I think you would see that the new shareholder debt could be written off the books with distributions and payback in the end result the same as a redemption of the old shareholder.

                            **Edit: To give him stock basis the entry would credit capital stock (shares issued) and debit (reduce) the SBA loan since you are saying the shareholder actually owes this debt and not the S-corp. The shareholder would then have to pay the SBA loan.
                            Last edited by OldJack; 10-09-2006, 06:08 PM.

                            Comment


                              #15
                              Old Jack,.......

                              ..... Are you saying that the old shareholder does not get taxed on the proceeds of the SBA loan (sale price)? And the sale is not a sale, or maybe for $1.

                              What about the assumed debt of the buyer. How does the seller deal with the debt he is leaving behind?

                              Doesn't this smell like a "subscription to stock".

                              If I were the buyer I would like "basis" for what I'm paying for, from net profits that I'm paying income taxes on. Your stock redemption leaves me no basis and all personal income taxes.
                              Last edited by BOB W; 10-09-2006, 09:13 PM.
                              This post is for discussion purposes only and should be verified with other sources before actual use.

                              Many times I post additional info on the post, Click on "message board" for updated content.

                              Comment

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