Distribution by S-Corp under dissolution

[JoshinNC]

S-Corp dissolves 8/10/06. Only assets on books are cash and truck, purchased in 2005, section 179 taken in 2005 for full cost ($5000). Upon dissolution all cash and truck are distributed to one of the two shareholders. Where is this distribution reported on K-1? My understanding of distributions of previous 179 assets is that they are listed on Sch. K Line 17d, code k, with some additional reporting required. Is this also true when distributed to a shareholder pursuant to dissolution?

Man, I have alot of questions today!

[OldJack]

The truck distribution is first reported as a sale at fair market value on 1120S-form 4797 to establish taxable gain/loss to pass to the shareholders on a per share basis.

The total distribution of cash and truck (at FMV) is shown also on line 16d as property distributions as this is the amount that reduces shareholder basis.

Line 17d is only for information to pass to the shareholder to recapture §179 depreciation they may have taken on the truck. This should not be necessary as the S-corp has "sold" the truck and taken any recapture into account with the calculation of the gain/loss on the sale as passed to the shareholders. Therefore, no entry on line 17d. Line 17d would most likely be used only when recapure is needed at the shareholder level because the asset is still owned by the S-corp but recapture is required due to use or status changes of the asset.

You may need to issue a 1099DIV for final distributions that are not tax-free distributions so that the shareholders may calculate their gain or loss on the disposition/sale of stock of the corporation and report the same on their 1040 Sch-D.

[JoshinNC]

thanks again Jack

You're are really saving my tail today.

I was leaning towards the sale at fair market value and reporting on 16, but was confused about the Sec. 179 recapture.

You're knowledge is invaluable. I'll have to send you a commission check at the end of "the season".

[OldJack]

>>I'll have to send you a commission check at the end of "the season".<<


You are welcome Josh. I'll be watching the mail box.

[JoshinNC]

Do I get an extension on the 1099

like the brokerage houses?

[OldJack]

I'll wait until after I cash your check to tell you that I will not give you my SS#. So no 1099 is needed as its just a vendor payment.

[dsi]

Josh, are you saying that only one of the two SH's is receiving the final distribution (both cash and truck)? I've never been involved in a situation where there were unequal distributions and was wondering if this is o.k. to do with an s-corp?

[JoshinNC]

It is true that the other sh is receiving nothing,

I had not considered the one class of stock rule, and whether that would be a violation thereof.

Great point (and one more headache to think about).

[OldJack]

I've never been involved in a situation where there were unequal distributions and was wondering if this is o.k. to do with an s-corp?

Only under a plan of liquidation are unequal distributions not a problem as all shareholders have to vote and approve the plan of liquidation. In a plan of liquidation/termination of the corporation, the corporation is, in reality, purchasing/redeeming the shares of stock from the shareholders. In this case, as posted, shareholder 1 is receiving the S-corp truck and we assume that equal owner shareholder 2 has agreed to the uneven distribution. If all is reported properly the IRS could care less that there were unequal distributions.

For simplicity lets look at an example of what tax effect and transactions take place. Again to keep it simple, and not deal with journal entries, lets have shareholder 1 pay cash for the truck and then unequal distributions of the cash:

Example Assumptions/ facts:
A) Shareholders are 50-50 owners of the S-corp.

B) The S-corp has no income or expenses for the current year other than the transaction of the truck and liquidation distribution.

C) Both shareholders before the truck sale have received all prior assets and profits by way of AAA distributions and therefore their basis in their shares are zero.

D) All shareholders agree to a plan of unequal distribution on liquidation of the S-corp.

E) Unequal distribution considered as a second class of stock terminating the S-corp status is immaterial as the corporation terminates with the liquidating distribution and tax status no longer matters.

F) A distribution in excess of basis is treated as a sale/redemption of stock reported as a capital transaction on 1040 Sch-D. Likewise, when a corporation terminates all shares of stock are considered redeemed with the shareholder reporting the redemption/sale on 1040 Sch-D.


Transactions:
1) The S-corp sells shareholder 1 the truck for a fair market value of $6,000 cash paid and driven away. The S-corp only asset now is the $6,000 cash.

2) The S-corp had fully depreciated the truck so the 1120S-form 4797 shows ordinary income of $6,000 with the gain flowing thru to each shareholder in the amount of $3,000.

3) Each shareholder now has $3,000 stock basis as income adds to basis.

4) The S-corp now makes an uneven cash distribution of $6,000 to shareholder 1 and zero to shareholder 2 per the approved plan of liquidation.

5) The S-corp now with no assets or liabilities, files all final tax returns and documents to legally dissolve.

6) Shareholder 2 reports on his 1040 Sch-E, the $3,000 income from the k1 and reports on 1040 Sch-D the sale/redemption of his shares of stock at zero sale price with cost basis of $3,000 for a long-term loss of $3,000. The net result being $3,000 income with $3,000 loss netting to zero for taxes.

7) Shareholder 1 reports on his 1040 Sch-E, the $3,000 income from the k-1 and reports on 1040 Sch-D the sale/redemption of his shares of stock at $6,000 price with cost basis of $3,000 for a long-term gain of $3,000. The net result being $3,000 income plus $3,000 gain totaling $6,000 taxable which appropriately happens to be the FMV of the truck.

All is well.

[dsi]

Should there be a written plan of dissolution/distribution and a completed 966?

[OldJack]

Should there be a written plan of dissolution/distribution and a completed 966?

In an ideal world there definitely should be proper documentation as you suggest, however, it commonly is just a verbal agreement between shareholders. In this example as long as shareholder 2 does not object, there is little to be concerned about.

[JoshinNC]

What if it's not sold?

Only under a plan of liquidation are unequal distributions not a problem as all shareholders have to vote and approve the plan of liquidation. In a plan of liquidation/termination of the corporation, the corporation is, in reality, purchasing/redeeming the shares of stock from the shareholders. In this case, as posted, shareholder 1 is receiving the S-corp truck and we assume that equal owner shareholder 2 has agreed to the uneven distribution. If all is reported properly the IRS could care less that there were unequal distributions.

For simplicity lets look at an example of what tax effect and transactions take place. Again to keep it simple, and not deal with journal entries, lets have shareholder 1 pay cash for the truck and then unequal distributions of the cash:

Example Assumptions/ facts:
A) Shareholders are 50-50 owners of the S-corp.

B) The S-corp has no income or expenses for the current year other than the transaction of the truck and liquidation distribution.

C) Both shareholders before the truck sale have received all prior assets and profits by way of AAA distributions and therefore their basis in their shares are zero.

D) All shareholders agree to a plan of unequal distribution on liquidation of the S-corp.

E) Unequal distribution considered as a second class of stock terminating the S-corp status is immaterial as the corporation terminates with the liquidating distribution and tax status no longer matters.

F) A distribution in excess of basis is treated as a sale/redemption of stock reported as a capital transaction on 1040 Sch-D. Likewise, when a corporation terminates all shares of stock are considered redeemed with the shareholder reporting the redemption/sale on 1040 Sch-D.


Transactions:
1) The S-corp sells shareholder 1 the truck for a fair market value of $6,000 cash paid and driven away. The S-corp only asset now is the $6,000 cash.

2) The S-corp had fully depreciated the truck so the 1120S-form 4797 shows ordinary income of $6,000 with the gain flowing thru to each shareholder in the amount of $3,000.

3) Each shareholder now has $3,000 stock basis as income adds to basis.

4) The S-corp now makes an uneven cash distribution of $6,000 to shareholder 1 and zero to shareholder 2 per the approved plan of liquidation.

5) The S-corp now with no assets or liabilities, files all final tax returns and documents to legally dissolve.

6) Shareholder 2 reports on his 1040 Sch-E, the $3,000 income from the k1 and reports on 1040 Sch-D the sale/redemption of his shares of stock at zero sale price with cost basis of $3,000 for a long-term loss of $3,000. The net result being $3,000 income with $3,000 loss netting to zero for taxes.

7) Shareholder 1 reports on his 1040 Sch-E, the $3,000 income from the k-1 and reports on 1040 Sch-D the sale/redemption of his shares of stock at $6,000 price with cost basis of $3,000 for a long-term gain of $3,000. The net result being $3,000 income plus $3,000 gain totaling $6,000 taxable which appropriately happens to be the FMV of the truck.

All is well.

In your scenaio the shareholder gave the corp $6000 for the truck (which had basis of $0). What if the shareholder gave the corp $0? I'm really having trouble with this for some reason.

[OldJack]

In your scenaio the shareholder gave the corp $6000 for the truck (which had basis of $0). What if the shareholder gave the corp $0? I'm really having trouble with this for some reason.

When you make the journal entry to record the "sale" at fair market value (say $6,000) with (say $14,000) original cost fully depreciated, it would be something like this on the S-corp books:

Entry for sale of vehicle -
6,000 credit - Sale of Asset Account (misc income account) income account
6,000 debit - Due from shareholder (acct receivable) (could be to property distribution account and skip distribution entry below)
14,000 debit - Vehicle Accumulated Depreciation (to zero balance sheet negative asset account)
14,000 credit - Vehicle Asset Account (to zero balance sheet positive asset account)
To recognize sale at FMV of $6,000 with payment due from buyer and to remove original vehicle book purchase price and remove accumulated depreciation from balance sheet accounts.

Entry to distribute vehicle without payment-
6,000 debit - Property distribution (equity section: cash distributions/ capital withdrawal)
6,000 credit - Due from shareholder (acct receivable) shareholder no longer owes.
To zero the receivable due from the shareholder and charge the amount due as a property distribution (account is sometimes called cash distribution)

Results on the 1120S tax return: also flows to k-1's
6,000 income on form 1120S-form 4797.
6,000 property distribution on 1120S-line16d.

14,000 asset on 1120S- Sch-L, balance sheet, page 4, line 10a & 10b, previously shown is no longer an asset.

[JoshinNC]

Now it's all so clear.

Thanks again, Jack.