S-Corporation Bankruptcy

[geekgirldany]

This is a little confusing. But hopefully you all can help me. This is a long one.

Client had S-Corp A. Sole shareholder was wife. Due to various personal reasons a new S-Corp B was setup has husband for sole shareholder.

Both S-Corps are on Accrual basis.

S-Corp A was closed down for tax purposes in 2nd qtr 2007. Return was marked finial for that year. The S-Corp still owed payroll taxes which went forward to the sole shareholder to have to pay. To my knowledge there was no other debts owed. Everything balanced out when I went through the final return.

Come to 2009, I find out there was an existing lawsuit with a customer in S-Corp A. Again due to various reasons the judgment was ruled in favor of the customer. Around $70,000.

Well clients decide to bankrupt the S-Corp A because the $70,000 can not be paid. While doing this they included credit cards that were still in S-Corp A name but S-Corp B had using and paying on the cards. Not known to me. I told them to switch everything over... but they did not.

So now S-Corp B has balances on several credit cards, around $30,000, that will never be paid. The cards were cleared during the bankruptcy process of S-Corp A. Bad year in 2008 & 2009 for the company so alot of expenses were put on the credit cards.

Okay long story shorter I hope now....

What to do with these credit card balances in QBs and for Tax Purposes?

Would these be considered cancellation of debt income and added as income on S-Corp B?

[Harvey Lucas]

Trace the Debt

What portion of the 30,000 credit card debt was from S Corp A?

If S Corp B was making the payments on the card, then you need to decide if the payments were for the old S Corp A balance or if they were payments for new expenditures of S Corp B.

If the payments were for the S Corp A balance then those payments are, Loans to S Corp A?, or Distributions to Shareholder of S Corp B who then gifts the money to Shareholder A to make a capital contibution to S Corp A to make the payments?, or ?.

I would divide up the credit card debt based on the amount incurred by each corp.
Then decide how to treat the payments, if any, that S Corp B made toward S Corp A's old balance.

If the total debt was cancelled in BK action, S Corp A has no cancellation of debt income since it is insolvent.

The portion of the debt that belonged to S Corp B is another story. Sounds like cancelation of Debt income to me for S Corp B on that portion of the debt.

Harvey Lucas

[JON]

I would bet

1. The second S corp would be liable for all debts of the first if any creditor wanted to go after it. I would think any lawyer would easily be able to include B in any actions against A. Any actions that were done in anticipation of bankruptcy are voided by the courts usually.

2. The credit card debt if not paid because no one goes after B is income to B.

3. My guess is the stockholders better hope no one goes after them. I would think they have made a trail that leads directly to them. I hope the type of business in B has nothing to do with A's previous business??!! Bankruptcy for A should have happenned first before B is formed if it is conducting A's business.

Good luck.

[ChEAr$]

An attorney should be consulted on this one.

Particularly important is whether or not the corporation existed at time of suit and judgement.
Were articles of dissolution ever filed with Sec of state in Atlanta? In 2007? when? when
was that corporation sued? If the corporation didn't exist when sued, is there in fact any
liability remaining?

[WhiteOleander]

Something keep binging in my brain about a corp deducting expenses that it did not pay. Technically, didn't corp A pay these expenses and not corp B?

So, if corp B has been deducting the expenses paid for by corp A's credit card, they didn't really have any expenses to deduct.

[dsi]

I will echo Chears's (Harlan) point: Work with an attorney on this one. Furthermore, consult your E&O carrier regarding your risk...that is, to be certain you are covered should something go haywire on you.

[geekgirldany]

Thank you all for the responses and taking the time to help me with this. I will have something to go by later today when talking to the client.

Well I guess I will have to talk to the attorney (or get the client to talk) to get the "actual" amount of debt that was canceled to double check.

From what I saw on SCorp A (QBs) there was NO balance with these credit cards at all. When I did the final return there was nothing there. So what they did was use the SCorp A credit cards for SCorp B expenses. All the $30,000 (showing on QBs) was on SCorp B.

Client would receive the bill from say Office Max, enter expenses, and then pay on that bill until it was paid off. It has been entered like this since middle 07.

Harlan, I told them to let the state do an administrative close. There was no article of dissolution filed with the state. I did a final return for SCorp A in 08. It "officially" closed middle of 07.

Yes it is the same business. There was personal reasons why a new SCorp was opened. Which I understand. I just wish I would have been told about the pending lawsuit. If I would have known I would not have filed a final return for SCorp A. I was told at the same time about the bankruptcy. Again it was already started before I could add anything.

To me I am thinking this is Cancellation Of Debt Income for S-Corp B. Since they are on the accrual method they have been deducting expenses from these cards. I believe since they will not be paid off then the balance should be included in income. I will see if lawyer agrees.

What it comes down to is that the credit cards should have been closed down. They continued to use them for the SCorpB. I don't know... confusing and aggravating situation.

[geekgirldany]

I also want to add something else about this bankruptcy stuff.

I have another client that is going through bankruptcy personally and with the s-corporation. After some questions I found out that she had not paid the annual renewal fee with the state since 2008. They always do an administrative close of the corporation if the fees are not paid. So for 2009 when the bankruptcy started there is really not a corporation... right?

What I get told by the clients are:

"The lawyer said he/she would take care of everything. Nothing to worry about. Everything will be wiped clean and we can start over".

Its like I am left totally out of the mix. I am standing there saying "But we planned on the S-Corp being closed this year".

That one client above... I haven't heard from so I am not sure what is going on.

On a personal level I don't agree with bankruptcy. Especially with credit cards. If you bought things with the cards then you should pay it back. It is only right.

[ChEAr$]

Harlan, I told them to let the state do an administrative close. There was no article of dissolution filed with the state. I did a final return for SCorp A in 08. It "officially" closed middle of 07.

Re "administrative close". This may be an easy solution in Georgia, but be sure to
ask lawyer about continued liability in a case where a corporation has NOT filed the
dissolution papers in a legal manner. I'm no lawyer (thank GOD!), but somewhere I
seem to remember that an administrative dissolution will not prevent someone suing
and sinning..

Ooops.. make that "and winning!"