Sale of Business

[JoshinNC]

This is the first one of these I have done, so I will need help.

One of my clients called this morning and informed me that they sold one of their businesses (they own two S-Corps, sold one) under an installment sale. He owns 100% of the shares of the S-Corp and is selling the business to a friend for a total of $140,000. He is recieving $50,000 down payment and continuing payments for 3 years. His cost basis in the business is roughly $225,000.

TTB pg. 25-3 says that a loss on the sale of any business asset is an ordinary loss. If this is true, that's great, in that he can offset income from his other business. But, would this not be a capital loss, calculated using his cost basis for the shares he owns and the cost per share that he is receiving? Maybe I'm lost. Like I said, first business sale, so any help would be appreciated.

[Bird Legs]

Question

Did your client sell the business or the stock?

[JON]

What did he sell

If he sold business assets get the list proceeds are what is stated and costs will be tax basis. You get a gain or loss based on the assets and take it on the Corp.

If the client's stock was purchased you have the gross sales price and the client's basis is what you keep track of from day one. Investment plus income - losses - distributions plus some others.

[Unregistered]

stock sale

They entered into a stock purchase agreement, so it would be the corporate stock that is being sold. My question then becomes, since my client will still own a majority of the shares at the end of year one, do we still need to file an 1120S, list both the shareholders, and continue to do so each year until the sale is final? Does my client recognize the loss each year as allocated to the shares actually sold that year. For example:

Stock basis = 1000 shares @ $250 a share

1st year client recieves $68000 ($50000 down, plus 9 monthly payments of $2000) = 486 shares @ $140 a share

Capital loss = $53,500 (486 shares @ $250 - 486 shares @ $140)

Am I on the right track here.

Of course, they would be limited on the capital gains loss to $3000 per year.

[JON]

They purchased 100%

I would think they purchased 100% of the stock with cash and a promise to pay. It would be strange to be buying a share at a time. Installment purchase of stock, would be my guess and he is out the day they signed and got the down payment. The S corp books would be done by the buyer-elect I think IRC SEC 1377 says I'm closing the books on the sale date in income and loss to that point is assigned to your guy(k-1) and after that to the buyer's K-1. If you do not make that election the income is split by number of days held for the year using the regular year end numbers...

[JoshinNC]

ok

so do we file a short year return up to the point of the sale?

I'll definately check out the code section you referenced.

thanks for your help.

[JoshinNC]

I think I have a little better understanding

After reading the code section and also reading TTB pg. 19-6 related to the election available it sounds as though this may be my client's best option. The filing deadline for the short year return would be the 15th day of the 3rd month following the total stock sale, right? or do they get to file both short year returns next March?

Thanks for all your help!

[JON]

No short term

return. There is one return filed by the buyer for the year. The above gives the two choices on how to split the income. Sale of stock the buyer assumes the sellers position. Usually in the purchase agreement the method of income allocation is decided. Otherwise I think it is up to the buyer as to what wants to do.

[geekgirldany]

One of my client's sold their S-Corp. Lawyer told them it would be better for them to do a sale of stock. The CPA said to make sure there is a "Election to Terminate S-Corporation's Tax Year" statement attached to the return. I assume this is only on the 1120s.

Goes like this,

"John Doe, Inc, hereby elects under Code Section 1377(a)(s) and Reg. Section 1.1377-1(b) to treat its taxable year ending December 31, 2005 as if it consisted of two separate taxable years. The first separate taxable year began on Jan 1, 2005 and ended June 31, 2005. The second taxable year began on July 1, 2005 and ended on December 31, 2005."

The statement then lists the former shareholder and the new shareholders with signatures. Old shareholder and new shareholders will get K-1's with the amounts divided up as stated above. This was/is an installment sale. I am coming up with a figure on their stock basis. THey want me to check that I come up the same basis as the new CPA does for the new shareholders. New CPA will be taking over preparation of 1120s.

Let me add that new CPA said that the sale of stock is more favorable for seller than it is for the buyer.

[oceanlovin'ea]

Cooperation great

Joshin NC, isn't it great that these people on this board with MORE experience are willing to help you with something you are doing for the first time? That is why I think the board is so great.

A few weeks ago when I asked a question about partnerships, you suggested I get the phone number of a good CPA and stop trying to do returns that I didn't know how to do.

I am so glad that no one told you that and that they were willing to help and answer your questions. We all need some help from time to time - that is why this board works so great. You help when you can and others help you when you need it too.

Oh, by the way I got the partnership done and I believe it is a correct return.

Linda F

[JoshinNC]

Linda

I think I went back and retracted that statement, but if not I apologize. When I originally read your post I was under the impression that you were not a tax professional and were just looking for answers to a generic question, which is what prompted my reaction. Please accept my apologies and I agree, cooperation between PROFESSIONALS is great, and allows for a free exchange of knowledge.

[OldJack]

The CPA said to make sure there is a "Election to Terminate S-Corporation's Tax Year" statement attached to the return. I assume this is only on the 1120s.

I believe that CPA must have been concerned about the new owner not properly closing the books and accounting for the profits for the K-1's as making that election to end the year is like killing a fly with a nuclear bomb. The new owner is the one that files the tax return and the seller doesn't even see the tax return plus the IRS could care less. The requirement to close the books and account could easily be a part of the agreement to purchase. Completely unnecessary unless the sale to the new owner was under some kind of duress. JON has the procedure right as outlined by the IRS publications.

edit: Also, the full 1000 share sale is reported on form 6252, "Installment Sale" as a code §1221 capital asset with gain from proceeds received flowing to 1040 Sch-D.

[Armando Beaujolais]

I believe that CPA must have been concerned about the new owner not properly closing the books and accounting for the profits for the K-1's as making that election to end the year is like killing a fly with a nuclear bomb. The new owner is the one that files the tax return and the seller doesn't even see the tax return plus the IRS could care less. The requirement to close the books and account could easily be a part of the agreement to purchase. Completely unnecessary unless the sale to the new owner was under some kind of duress. JON has the procedure right as outlined by the IRS publications.

edit: Also, the full 1000 share sale is reported on form 6252, "Installment Sale" as a code §1221 capital asset with gain from proceeds received flowing to 1040 Sch-D.

I disagree. The allocation of S corporation profit is made on a per-share per-day method. The total S corporation earnings are computed for the entire year. The selling shareholder will have $X.XX in earnings attributable to the period up to the date the stock is sold, and that amount will change as the earnings fluctuate the rest of the year if the election is not made.

Absolutely, make sure the election to treat the S year as two short years. It requires consent of all the shareholders, so it will need to be in the agreement. Otherwise somebody's going to come out on the short end of the stick and you can forget about agreeing to it later.

[JoshinNC]

Ordinary Income or Capital Gain?

Since this is a stock sale it qualifies as a capital loss, correct?

So, the excess of net losses over $3000 will carryover to future years, right?

There is no special rule that I need to know about with stock of closely held corps?

Thanks to all for your help!

[JON]

Code Section 1377 Armando needs

The above section allows to have an actual closing of the books on sale date. It gives all tax effects through that date to the seller and buyer will get the rest on his K-1. If you sell a profitable retail business October 31, and 90% of sales are holiday sales-the seller will get to pick al lot of the buyer's income for the year of sale. 1377 has to be insisted by the seller in some cases or at least know what they are negotiating for in the sale. There are cases where you should not want it split by days. 1377 allows that.

There is one return. The K-1 is the only place the spliting takes place. I also think it no longer takes signed agreement between "all" shareholders.