s corp sold business

[oceanlovin'ea]

Client who is a single shareholder in S corporation sold his business last year. He sold the business name and the customer base or good will. He did not sell any of the property of the business, such as small tools and an old truck. These had been fully depreciated several years ago. He kept these as he will do some repair jobs as a sole proprietor. The business was dissolved with the state as of 6/30/12. It no longer exists.
Since he started the business from scratch many years ago, the whole sales price is taxable as capital gains.

I had him bring to me the prior tax returns from previous preparer so that I could see what property the business owned. I don't have the tax return for the first year of the business which was 2004. But I have 2005. The only asset on that tax return on the balance sheet and the depreciation schedule is the truck. Same for 2006 and 2007. On 2008 return the depreciation schedule suddenly shows some other property that was sold in 2008. Now it appears on an amount appears on the balance sheet of that return which is different from the amount of sold property but doesn't include the truck.

Since he kept the property including truck, these have to be distributed to him on this years returns. I haven't done this before so I am trying to make sure I cover all the bases here. This distribution is on the personal tax return. Since they were fully depreciated, they have no basis and probably very little monetary value. Is there a value I have to place on these items that would show a profit to him in the distribution?

I have my NCPE book on business and my Small Business taxbook. I will do more research tomorrow afternoon. But just thought some of you might point me in the right direction for more reading. Also let me know if I am on the right track.

Thanks

Linda, EA

[ChEAr$]

Consider this. Since the corporation was dissolved in 2012, all distributions occurred in that year, and not on the current (2013) return.
Unless of course, you mean 2012 as "current return", meaning it's 1120s was extended back in March.

[Bees Knees]

If the corporation owned the truck and tools, and the corporation did not sell these items to the buyer, then they are considered distributions to the shareholder when the corporation is liquidated (not necessarily the same date the goodwill was sold to the buyer). Upon liquidation, the assets are treated as if they are sold to the shareholder at FMV in exchange for the shareholder's stock. So if the corporation has zero basis in the assets (because they are fully depreciated), then the gain will equal the FMV of each asset, taxed as depreciation recapture (ordinary income) on the S corps final return. This gain then flows through to the shareholder on the K-1. The gain also increases the shareholder's basis in the S corp, which will produce a capital gain or loss when the corporation is liquidated. Thus, the shareholder reports gain from the K-1 on the 1040, and also reports gain or loss on Schedule D of the 1040 for the liquidation of the shareholder's stock, with the gross proceeds equal to the cash and FMV of the truck and tools distributed to the shareholder, and basis equal to the shareholder's stock basis (which has been increased by the sale of the goodwill and the gain on the distribution of the truck and tools).

The new sole proprietor gets a basis in each asset equal to its FMV, since the shareholder in effect has purchased the assets from the S corp at their FMV. They can then be depreciated at their FMV on the sole proprietorship return.

There is a sale of an S corporation example on page 27-9 of TTB Small Business Edition which shows the specific forms and lines that each item is reported on the 1120S and 1040.

[oceanlovin'ea]

2012

Yes, I did an extension and am completing the 2012 tax return.

Thanks Bees for the reference. That is just what I needed. I am a visual person. I need the examples shown to me and I can follow it through.

I'll holler if I get stuck.

Thanks

Linda, EA

[oceanlovin'ea]

problem?

What is kind of giving me a problem is that I really don't know what equipment the company owned. The balance sheets of the 1120S are different from year to year. At first the only thing on there is the truck. Then in 2008 several things are listed as being sold. They were never on the return before. So technically the only asset the business owns is the truck. And the cash he kept.

Guess I answered my own question.

Linda, EA

[Bees Knees]

Well, I would ask the client to tell you what assets he took out of the corporation (besides the cash) and to give you an estimate as to how much he thinks they are worth.

Like maybe $500 for the truck and $100 for a bunch of miscellaneous tools. Something like that.

[oceanlovin'ea]

Actually when I looked back at the 2008 return he had sold the truck then. The business has been reimbursing him for his truck expenses for the last few years. I did email him and he told me what he still had and the value of those things....amounted to very little. I put that on the 4797 part II and it went to the front page of the 1120S just like the example. YEA!!

The amount he received for the name of the business and the client list is capital gain. I know that it goes to the 1040 but do I just put it on the Schedule D?
The example has an installment sale. So I am trying to read around that situation.

Ok. too tired to think anymore. I'll take it up in the morning.

Thanks.

Linda, EA

[oceanlovin'ea]

basis in stock

This is the point I am at now. I am looking at the oldest tax return for the corporation that I have, which is 2005. The business started in 2004. On the balance sheet (schedule L) there is capital stock of $5383 and paid in capital of $5971.

On Schedule M the beginning balance is 12,388.

I know that I add each years income plus adjustments minus distributions to come up with the basis in stock. What figure am I starting with? Is it the total of the capital stock and paid in capital? Or do I just use one of those figures. I would think that the $5383 might have been the cash that he put in the business when it became an S corp and maybe the paid in capital was the basis of the equipment that he gave to the company. But I don't know and I know this client wouldn't remember what happened almost 10 years ago.

Then since all he has is cash left as an asset the cash minus the basis would be his gain on the sale of the stock?? Am I correct??

I really appreciate your help so much.

Linda, EA

[Bees Knees]

The corporation sold the name of the business and the client list, so the capital gain goes on the 1120S, which then flows through to the shareholder on the K-1, which in turn increases his basis for that year.

The beginning basis should be both capital accounts when the corporation was first funded. He is going to have to prove both amounts if audited. Then it is just a matter of adding and subtracting income and loss items on the K-1s each year, minus any distributions. The difference between what he got in the end minus his remaining adjusted basis is your gain or loss that is reported on Schedule D.

[oceanlovin'ea]

Ok..I will put the sale of the business name and client list on the 1120S, which goes on schedule K.

Then I will take the beginning balance of capital stock and paid in capital plus the income for each year, plus or minus any adjustments, and minus distributions. Then I will add the amount of the capital gains to that amount (you said it increases his basis for 2012). That will be his basis in the stock and the cash he got from the company is the sales price.

Am I following you correctly? Let me know if there is anything that I just said that is wrong or if I have left anything out.

Bees, you are a lifesaver. I have never had someone sell their business before. Especially an s corp. So if you are ever in central Florida, let me know. I'll buy you a steak dinner. If I'm ever in Tennessee, I'll still buy you a steak dinner.

Linda, EA

[oceanlovin'ea]

Thanks

Thank you so very much for all your help again.

Client came to pick up returns. Very satisfied. Recognized the amount of work that was involved and appreciated all my effort. Good people.

I am glad that is behind me. I really learned a lot.

Linda, EA