SALE OF C CORP & ACCTS RECEIVABLE

[Mark Goldberg]

My client sold 100% of his shares in a C Corp. In addition to payment for the shares, he received $25k to compensate him for accounts receivable that were paid to the Corp after the sale. How do I report this on his Form 1040?

[OldJack]

As a personal sale of the C-corp stock on 1040 Sch-D. It is just a way of valuing the gross sale price of the stock as he can't sell the receivables when the C-corp owned the receivables, not him personally.

[Mark Goldberg]

I Don't Follow

Old Jack, are you saying the $25k is reported as an additional long term gain.
I assume if this is so, that it does not get section 1202 gain treatment like the rest of the gain is getting because it is not stock.

[BOB W]

Cash Or Accrual

What accounting method is the C Corp using?

Does the sales contract mention the accounts receivable?

[Mark Goldberg]

Thanks Bob W

Per your suggestion I loked at the contract and it says acct receivable shall be ordinary icnome to the seller.

[OldJack]

If it is deemed to be a part of the gross sale price of the stock it should qualify under §1202 for exclusion of 50% of the gain. However now we must consider, as subsequent post has said ,the contract spells it out as payment for receivables and ordinary income.

I find this difficult to understand as the taxpayer did not own the receivables and nothing else was sold other than stock. I guess the taxpayer can consider the amount received as ordinary miscellaneous income or as a dividend. Hope the IRS doesn't audit and reclassify the payment as a dividend for the corporation thereby disallowing an expense deduction for the corporation.

[BOB W]

No .................

,,,,,,,,,,,,,,,, problem. Glad to put my 2 cents in.

[Bird Legs]

Cash received after stock sale

Who received the money that was paid on the receivables? The corporation or the seller?
As Old Jack says the accounts receivable belonged to the corporation. Therefore, any
payments made on the A/R after the sale should go to the corp.
If the seller retained any of the Receivables, this would be a dividend, distribution, to him/her and this distribution would be taxable. Any payments received should not be
taxable.

[veritas]

I see sales like this all the time. It drives me nuts. I remember when we bought our practice from my father. dad "What about all the money in the bank?" me "No problem dad" Take it out and we will just reduce the purchase price of the stock" dad "What?"

[BOB W]

Interesting......

..... to see how the C Corp handles the payout and how this "ordinary income" gets reported, 1099 maybe,> subject to SS.

[Bees Knees]

If the sales contract says the accounts receivable is ordinary income to the seller, then what they buyer wants is for it to be treated as compensation, such as a bonus, deductible as wages paid, or something like that. They might not be calling it that, but that is what it would have to be treated as. It is either a sale of stock, or a bonus arrangement for past employment. You can’t call it the sale of accounts receivable since the stockholder did not own any accounts receivable to sell.

[OldJack]

I agree it can't be a sale of accounts receivable. You can't sell something you don't own. It also can't be a bonus arrangement for past employment as the contract calls it accounts receivable and a employee bonus would have to be thru payroll with related taxes.

I still think that it is more properly treated as part of the gross sale price of the stock even though it was in consideration of some form of equity in corporate receivables. It had to be part of the negotiated price of the sale of the stock. If that is not the case then it must be a taxable dividend from the C-corp.

Truth is that what the contract calls it doesn't control for what its called for federal tax purposes.

[BOB W]

It is obvious.......

........ that the Corp wants a write-off for a sum of money equal to the AR at time of sale. The sale price did not include the uncollected funds. Depending on their accounting method, probably CASH basis, the buyer did not want to assume the AR profit so he elected to payout the AR as ordinary income, which it would of been if left in the C Corp.

During negotions the true sales price was probably lowered to account for the ordinary income yet to be reported ( cash basis).

I can see how they got to this point, but a stock sale is usually pretty clean, X=stock ownership. Generally there is no other outside payments involved. But why not, as long as the selling stockholder reports this extra ordinary income IRS won't care. But as mentioned before, the IRS could call this a dividend issued by the C Corp. In this case the seller may be entitled to a flat dividend rate.

Mark, if the seller is your client and he agreed to the contract, which he did, ordinary income is the way to go. The buyer here is at risk for a proper treatment at the corporate level. The buyer should issue a W-2 to close any open door for dividend treatment down the road.

Not knowing the extent of profit envolved and not knowing how a bonus type check fits into to overall operation and how it would look to the IRS, it could always still be reclassified as a dividend>>>> highly unlikely....

[OldJack]

<< as long as the selling stockholder reports this extra ordinary income IRS won't care.>>

Well of course the IRS would not care as they are getting as much as double extra tax with it being classified as ordinary income to the seller. That is probably an extra 10-15% depending upon what tax bracket plus they may want an additional 15% for self-employment tax as the unrecorded receivables may be considered by the IRS as earned income to the seller. Not likely SE tax but could be an auditor's position in lieu of it not being treated as payroll with taxes withheld.

The fact that it was defined in the negotiated contract for the sale of the stock to me says it is part of the sale of the stock as that is the only thing that was sold. I guess a case could be made that as a shareholder sold his "interest" or "right to receive proceeds from" in the corp receivables, but again that is his interest that is owned by the shares of stock he owned and sold. Remember... legally a shareholder only has rights given him by his shares of stock, he does not own the assets of the corporation. Just because the taxpayer agreed to a tax treatment in a contract does not make it so with the IRS tax laws.

[Bees Knees]

Worst case scenario is the IRS does not doing anything to the seller for reporting it as ordinary income, but then denies the buyer from deducting the payment as a current expense, calling it rather a capital expense. The buyer and seller are two separate unrelated taxpayers. So what prevents the IRS from not treating the transaction consistently between the two?