New S Corporation Shareholder - How to treat transfer.

[Hamacher]

I have a client that started business about 2 years ago. They have had losses for the last 2 years but will start generating significant income in 2010. They have an employee that they told would be given 20% ownership if she stayed with the company for 2 years. The equity accounts are currently negative. Although losses have passed out to the original owners, they have not had enough basis to use the losses. What is the tax consequence to each party in the transfer of ownership? What is the best way to account for the transaction?

Thanks in advance for your help!

[ChEAr$]

I have a client that started business about 2 years ago. They have had losses for the last 2 years but will start generating significant income in 2010. They have an employee that they told would be given 20% ownership if she stayed with the company for 2 years. The equity accounts are currently negative. Although losses have passed out to the original owners, they have not had enough basis to use the losses. What is the tax consequence to each party in the transfer of ownership? What is the best way to account for the transaction?

Thanks in advance for your help!

No tax consequences to other parties. Since book value of stock is most probably
zero, present two guys turn back to corporation 1/5 of each one's stock, leaving each with 40% of oustanding stock, then corporation issues 20% to the new buy.

Example, 1000 shares outstanding. Each guy turns back to the corp 100 shares,
then 200 shares are issued to new guy.

Remember, only thing that matters to first two are their outside basis in the corp.

[S T]

Employee

Isn't there something about a gifting rule to employee and it is has to be included as taxable wages?

I thought I had a very old post on this issue, but I haven't been able to find it

Sandy

[ChEAr$]

Isn't there something about a gifting rule to employee and it is has to be included as taxable wages?

I thought I had a very old post on this issue, but I haven't been able to find it

Sandy

Reason I didnt' bring that up Sandy, is since OP said two years worth of losses, so that
would make book value of stock zero; rather less than zero.

[Hamacher]

Reason I didnt' bring that up Sandy, is since OP said two years worth of losses, so that
would make book value of stock zero; rather less than zero.

Actually book value is less than zero. The equity went negative but not as a result of distributions.

Would the new owner start out with zero capital account and the remaining owners maintain there negative balances? I know distributions have to be done in proportion to ownership percentages but do the capital accounts have to remain in proportion as well?

Regarding treating the transfer of ownership to the new owner, the book value is negative which means that she is not receiving any value. So there would be no reason to treat it as compensation. She is just going to be able to take advantage of any future earning streams.

Thanks again for the help!

[ChEAr$]

Actually book value is less than zero. The equity went negative but not as a result of distributions.

Would the new owner start out with zero capital account and the remaining owners maintain there negative balances? I know distributions have to be done in proportion to ownership percentages but do the capital accounts have to remain in proportion as well?

Regarding treating the transfer of ownership to the new owner, the book value is negative which means that she is not receiving any value. So there would be no reason to treat it as compensation. She is just going to be able to take advantage of any future earning streams.

Thanks again for the help!

Remember that there are two types of basis: inside and outside.

Inside basis would be the new owner's 20% of any negative amount.
Outside basis will be zero.
Compensation isn't a factor.

[Hamacher]

Remember that there are two types of basis: inside and outside.

Inside basis would be the new owner's 20% of any negative amount.
Outside basis will be zero.
Compensation isn't a factor.

YES... I understand there are two types of basis. Would the inside basis be 20% of the negative amount or would the new owner start at zero? Obviously, the original owners have been distributed losses, which is what created the negative basis. If the new owner takes 20% of the negative basis, do the original owners have income? I know that distributions have to be prorata based on ownership percentages but do the equity accounts have to ALWAYS be in proportion? That is why I was thinking that maybe the new owner would simply start at zero.

Thanks again for your help!

[geekgirldany]

Isn't inside and outside basis partnership terms? I did not think there was an inside basis in S-Corps.

To me I do not think the employee can receive a negative basis in the stock so... I believe it would be zero basis.

[ChEAr$]

Isn't inside and outside basis partnership terms? I did not think there was an inside basis in S-Corps.

To me I do not think the employee can receive a negative basis in the stock so... I believe it would be zero basis.

Inside basis for a stockholder in an S corp will be (in this case) zero, iow, not less than
zero.
and actually outside basis in this case will also be zero.

Haven't thought about any offsetting entry on corporate books , but logic says there should
be one on the asset side to reflect change in book value of the stock. Maybe later. (grin
(rough day here!)

[Hamacher]

Thanks

Isn't inside and outside basis partnership terms? I did not think there was an inside basis in S-Corps.

To me I do not think the employee can receive a negative basis in the stock so... I believe it would be zero basis.

That is what I was thinking. It would seem to be cleaner if the new owner had a zero basis and the previous owners would maintain their carry over negative basis but I wanted to make sure that is correct. I've asked a couple local accountants/CPAs and they can't seem to give me a definitive answer. I originally thought it was a straight forward questions but I guess not.

Thanks for the input.