Discharged debt to S Corp Shareholder

[DaveinTexas]

I have a client that is dissolving his S Corp. He has about $15k in outstanding loans from the S Corp to himself.

When he dissolves, how do you handle the discharge of debt?

Ordinary income to shareholder?
Loss to S Corp, but no benefit to S Corp?

TIA

[DaveinTexas]

One quick side note to this

His stock basis is $17,263 currently and the outstanding debt is $14,615.

Would the discharge of debt reduce his stock basis or is this a non-issue?

Hep me buddies!

[Bees Knees]

I am assuming that although his stock basis is $17,263, he doesn’t have any cash in the S corp to pay back his loan from himself. That is why you are calling it discharge of debt. Assuming nothing is left in the corporation to trade for the liability, the stockholder is basically experiencing a loss on an uncollectible debt. The stockholder is not forgiving the debt. There is a difference between forgiving the debt, and having the debt be uncollectible. Forgiving debt would mean taxable ordinary income to the corporation, which flows through to the shareholder on the K-1. That increases the shareholder’s basis, but who wants to report ordinary income all at once, and then deduct $3,000 of capital losses for a number of years to offset that?

What is happening is the corporation is simply not able to pay the debt back. So the shareholder has a capital loss on the amount that represents his basis in the debt. I would thus assume that out of his $17,263 basis in the S corp, $14,615 represents his basis in the debt that isn’t being paid back, thus a capital loss on that bad debt. In addition, the remaining basis in his stock would offset the value of any other asset being distributed upon liquidation, which should be next to nothing, other wise the value of those assets should have been used to pay back a portion of the debt first prior to being available as a shareholder distribution. Generally, the creditors have to be paid off with whatever is left in the corporation prior to liquidation. Anyway, the end result is, if the corporation has nothing to give to the stockholder to satisfy his debt, or his stock basis, the whole $17,263 of stock basis represents a capital loss to the shareholder upon liquidation.

[Bees Knees]

My last post probably made it more complicated then it had to be. It doesn’t matter whether it is loan basis or stock basis. It all adds up to a net capital loss.

To simplify matters, simply report the value of what ever is left in the corporation being distributed to the shareholder upon liquidation on Schedule D as gross proceeds, then add up total loan and stock basis ($17,263) and enter that under cost basis on Schedule D, and the difference is a net capital loss. Period.

[DaveinTexas]

Thanks much.