confusing situation

[theresa d]

situation is 2 shareholder S corp. corp is losing money and shareholder A decides he wants out. writes a letter to shareholder B 1-1-05 that he is relinquishing all interest in corp. not clear if stock was surrendered.

Shareholder B is my client. He now wants me to prepare the corporate return.

questions-

Can shareholder A just walk away? Can he just surrender his stock? corp will generate a loss in 2005. The loss will flow to shareholder B on his K-1 as he is now the only shareholder ? however will be limited by his basis.

if this can be done there are some fixed assets owned by the corp which shareholder A walked away from. what are the implications?

very messy situation. thanks for any help

[Bees Knees]

TTB, page 9-20 says "when an asset is abandoned, loss is recognized in the amount of adjusted basis at the time of abandonment. In order to qualify, the intent of the taxpayer must be irrevocably to discard the asset so that it will neither be used again nor retrieved for sale, exchange, or other disposition."

The context of page 9-20 applies to depreciable assets, but the principal is the same for capital assets, such as the abandonment of stock.

IRS Pub 544 says: “The abandonment of property is a disposition of property. You abandon property when you voluntarily and permanently give up possession and use of the property with the intention of ending your ownership but without passing it on to anyone else. Loss from abandonment of business or investment property is deductible as an ordinary loss, even if the property is a capital asset. The loss is the property's adjusted basis when abandoned. This rule also applies to leasehold improvements the lessor made for the lessee that were abandoned. However, if the property is later foreclosed on or repossessed, gain or loss is figured as discussed later. The abandonment loss is deducted in the tax year in which the loss is sustained. You cannot deduct any loss from abandonment of your home or other property held for personal use.”

[OldJack]

Its really not messy. Shareholder A has surrendered his stock to either the corporation (treasury stock) or Shareholder B (depending upon the letter wording), at a sale price of zero. For the entire year 2005 there is only 1 shareholder to allocate 2005 profits or losses regardless if the stock is considered treasury stock, redeemed shares, voided or canceled shares.

The corporation owns all assets... not any specific shareholder. If Shareholder A walked away with any corporation assets it must be treated as a S-corp taxable sale, at fair market value, taxable income to Shareholder A and taxable gain/loss to the S-corp.

Shareholder B now has the right to the entire balance (if any) of the AAA account (not taxable earnings). Shareholder B's outside basis determines if he can deduct the loss.

[OldJack]

The context of page 9-20 applies to depreciable assets, but the principal is the same for capital assets, such as the abandonment of stock.

Abandonment would only apply in this case to the Shareholder that walked away and not the corporation or remaining shareholder. The poster's question has to do with the remaining shareholder and the S-corp where there is no abandonment.

[theresa d]

basis

thanks for the responses. old jack , just to clarify does shareholder B's basis remains the same-his original contribution and loans that were outstanding to the corp adjusted for the losses which have been taken in prior years? The AAA account would be negative as the corp has been incurring losses. There was a loan to Shareholder A which was outstanding. this would become taxable to the corp as forgiveness of debt income. so in effect shareholder B's basis is adjusted for this remaining basis of shareholder A by the corporation picking up the debt forgivness income which reduces the loss which passes to Shareholder B? correct? sorry for my convoluted thinking-just trying to figure out the flow of the pieces left behind by Shareholder A. appreciate your imput

[OldJack]

thanks for the responses. old jack , just to clarify does shareholder B's basis remains the same-his original contribution and loans that were outstanding to the corp adjusted for the losses which have been taken in prior years? The AAA account would be negative as the corp has been incurring losses.

Shareholder B's (the remaining shareholder) basis stays the same even though his share and percentage of the value of the S-corp may have increased or decreased.

There was a loan to Shareholder A which was outstanding. this would become taxable to the corp as forgiveness of debt income.

To or from shareholder A? ... that is the question. If the S-corp owes shareholder A... I would think he would be wanting it paid back. You might consider if this loan is from the shareholder that it should be capitalized as equity rather than income under the theory that it really should have been equity due to capital needed for losses and startup of the new corp. If you did capitalize as equity you would probably have to do the same for any loan from shareholder B.

so in effect shareholder B's basis is adjusted for this remaining basis of shareholder A by the corporation picking up the debt forgivness income which reduces the loss which passes to Shareholder B? correct? sorry for my convoluted thinking-just trying to figure out the flow of the pieces left behind by Shareholder A. appreciate your imput

This is not a partnership entity and therefore the stock basis of shareholder B does not change unless you are treating the event as an individual purchase of shareholder A's stock by the remaining shareholder B. Even if B was buying A it would be at zero so there would be no increase in B's basis. Look at it this way..B can't use A's basis because A will be deducting his basis as a loss on abandonment.

my 2¢±¾

[theresa d]

got it!

thanks old jack for the imput- it makes sense now.