Stepped-up Equipment

[Snaggletooth]

Owner of an S-corp died recently. Equity of only $20K, but evaluation including goodwill is over $100K. Estate is now owner of the corporation, and lawyer is wanting to terminate the corporation.

Assets in the corporation are at historical costs, including fully-depreciated items with considerable worth. The "stepped-up" basis does not apply to the equipment as the corporation may continue to operate as it always has, and its financials will continue to be based on historical value as if nothing had ever happened.

However, the value of the stock to the estate takes into account the "stepped-up" basis of the equipment and other assets. It's valuation for the state is $100/share, instead of only $20/share book value.

Not sure why attorney wants to terminate the corporation. If the shares are distributed to the heirs upon termination, does the corporation take profit on the transfer at FMV? I'm thinking this is going to cause someone to have to pay tax on the step-up. Not only that, but the goodwill probably does NOT transfer, as a sale is not certain. Then if the heirs sell for reasonable price, they will have to pay in the goodwill too, right?

Thanks for your help!

Ron J.

[Bees Knees]

If the estate distributes the shares of stock to the beneficiaries, thus allowing the S corporation to continue, you have no tax problem. The new S corp shareholders have a stepped up basis in their S stock.

If the corporation is liquidated, the S corporation has a taxable gain on the appreciation of its assets. This gain is passed through to the shareholders (beneficiaries of the estate). But the gain would then be offset by the loss upon liquidation, because the gain increases the shareholder’s basis in stock, which was already stepped-up to FMV. So by having the FMV over basis count again, you in effect double the FMV to the shareholder, and the liquidation of the stock would result in a loss, offsetting the gain.

Example. S Corp has one asset, land worth 100,000 and a basis of 20,000. 100% shareholder dies. Estate’s basis in S stock is stepped up to 100,000. S corp distributes the land to the estate in a liquidation. S corp has a taxable gain of 80,000, passed through to the estate on the K-1. The estate’s S corp stock basis is now 180,000 (100,000 + 80,000 K-1 income). The estate now has an 80,000 loss when it exchanges the stock for the land (180,000 basis in stock minus 100,000 FMV of land received). The two cancel each other out, so that the estate now owns the land outside of the S corp with a net gain of zero (80,000 gain combined with 80,000 loss = zero).

[JON]

Agree with Bees and Snaggle-BUT

First, you have to make sure the liquidation of the corporate assets and the stock happen in the same taxable year-1041 and 1040-so the offset happens. Most liquidations involve equipment sales ordinary income recapture and capital gains. So the stock loss-upon redemption has to match the year.