S Corp Stock Purchase with S Corp Loan

[Outlook]

Old Jack - interesting explanations of the two scenerios. If the the S-Corp has lots of cash, then yes, there are some interesting ways to handle the situation as you have described. If we determine that it is not a redemption, and we focus on your second paragraph (scenerio), the issue we would have is that the S-Corp does NOT have an abundance of cash to use the techniques you describe. Because of low cash, no distributions and payback can take place and the end result is that S-Corp is left having to pay off the $450,000 SBA loan (proceeds of which went to pay the old shareholder and on the balance sheet as a long term debt) and the new shareholder is left owing $450,000 to the S-Corp (a note in place signed by new shareholder with terms, listed on S-Corp balance sheet as Note - Due from Shareholder)? Correct? Which is how we recorded the transaction when we determined that the SBA loan was in the name of the S-Corp and not in the name of the new shareholder.

Debit Note - Due from Shareholder $450,000
Credit Long Term Liability $450,000

Again you thoughts are appreciated. I know, your probably ready to hit me over the head by now - but the shareholders (old & new) we're dealing with here are not as sophisticated as you'd like to give them credit for, the banks certainly are not thinking about the tax ramifications and there is precious little cash to perform the informed techniques you've described. Thank You!!!

[Outlook]

Veritas - We double checked the loan documents and they are clearly in the name of the S-Corp with the new shareholder personally guaranteeing the loan tho the S-Corp.

[OldJack]

..... Are you saying that the old shareholder does not get taxed on the proceeds of the SBA loan (sale price)? And the sale is not a sale, or maybe for $1.

No Bob, I did not mean the old shareholder would not have taxes to pay. The question is how much is taxable. Again, take the new shareholder out of the picture, take the loan out of the picture, and say the old shareholder simply wants to take money out of the S-corp. First money distributed to him is the AAA account balance, second is E&P of which there is none, third is OAA account of which there is none, forth is return of capital with any excess is capital gains subject to tax (total or partial redemption of stock). The $1 example was for the sale of stock by the S-corp at fair-market-value to the new shareholder which would then have a stock basis of $1 or whatever.

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What about the assumed debt of the buyer. How does the seller deal with the debt he is leaving behind?

The question is what did the new person buy and with what? My take on it is that the new person bought new shares of stock as issued from the S-corp and that the S-corp made distributions to the old shareholder plus redemption of the old shareholders stock. A corporation is allow to do that as long as it is not with related parties. A corporation is not allowed to assume debt that is the debt of its shareholders when it is of no interest to the corporation to do so. What value was it to the S-corp to agree to a loan debt of $450,000???

The seller leaves behind the assets and liabilities of the S-corp when his stock has been redeemed the same as if he sold the stock direct to an individual.

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Doesn't this smell like a "subscription to stock".

Of course, facts in the post indicate new shares were issued. The question is at what value should the new shares be issued? Why would the new shareholder want to pay more for the stock than the fair-market-value of the corporation. Again, the SBA loan is not a debt of the new shareholder. It certainly can't be a debt by the S-corp and the new shareholder at the same time (I'm not counting pesonal guarantees).

There is nothing wrong with the way this is done, from an economic point of view the new shareholder is getting a corporation that is worth less because it has to pay the SBA loan. Also, the new owner is giving up tax-free AAA account (if distributions+stock redemption) that he would have if he purchased stock direct from the old shareholder.

If I were the buyer I would like "basis" for what I'm paying for, from net profits that I'm paying income taxes on. Your stock redemption leaves me no basis and all personal income taxes.

I agree that I would like basis for stock, however, you usually get what you pay for and this new shareholder has not paid for stock basis or assumed any debt for stock that would give him basis.

I may not be able to continue this discussion due to a family emergency that will take me out of town tonight as soon as I can pack. You guys figure it out.