1120s corporation?

[TAX4US]

Maybe a dumb question here. During the year Shareholder #2(only 2 shareholders in corp) bought out shareholder #1 for the value of the stock on the balance sheet. Since this is now a 1 shareholder 1120s does the value on the balance sheet change? I did find out that shareholder #2 also paid #1 his share of the (as they said) retained earnings, however I think they were referring to the accumulated adjustments account or his share of the profits this year, still not sure on this. Corp has always been a S corp. Anyone with thoughts on this appreciated. Thanks

[MichaelG]

Maybe a dumb question here. During the year Shareholder #2(only 2 shareholders in corp) bought out shareholder #1 for the value of the stock on the balance sheet. Since this is now a 1 shareholder 1120s does the value on the balance sheet change? I did find out that shareholder #2 also paid #1 his share of the (as they said) retained earnings, however I think they were referring to the accumulated adjustments account or his share of the profits this year, still not sure on this. Corp has always been a S corp. Anyone with thoughts on this appreciated. Thanks

It's not a dumb question at all. Clients often do deals like this without first asking how things should be done. Could you clarify a couple of things?

Was this a stock purchase? (Shareholder #1 buys shareholder #2s stock in the corp.)
If so, did shareholder #1 use their own money or was shareholder #2 paid directly out of the corporation's funds?
It sounds like the two shareholders just agreed on a selling price without an independent valuation or other attempt to determine FMV. Is that correct?

[ChEAr$]

This has nothing to do with corporate balance sheet, just as when/if I sell 1000 shares of FOrd stock, it doesn't affect FOrd's balance sheet.
Only thing happens is that selling shareholder's stock certificates must be given over to the secretary for canceling with new certificate to buyer for that number of shares.

Also remember the formula for pro rating net profit when preparing the 1120S and the K-1's.

[TAX4US]

They apparently agreed on a price and the buying stockholder used his own money to buy out. Seems rather high to me based on what I saw on the books as profit over the years though. Looks like I leave stock alone on the balance sheet. I do realize I need to adjust profits to date of sale. Question presents itself as do you use the formula as stated in 1377 or do two returns and then marry them together into one. It appears that the reg under 1377 presents and easier way to do this and I am all for easier. Thoughts?

[JohnH]

I think the easier way to do it is to produce a single return and allocate based on days of ownership.
But sometimes that produces a result that isn't favorable to one of the shareholders.

[MichaelG]

Per-Share/Per-Day

The normal way of dealing with the situation when there is a change in ownership is to file one return. Each shareholder's K-1 needs to be prepared allocating pass-through items on a per-share/per-day basis. Good tax software makes this a very simple process. Remember that distributions to shareholders must also be pro-rata.

In order to file two short-year returns, certain requirements must be met and an election to do so must be attached to the 1120S for the tax year for which the election is made. This is a lot more work, but there may be circumstances in which it is more equitable to the shareholders. (If the business is highly seasonal, it might make a big difference to one or more shareholders.)