Family Business Sale

[JohnH]

Potential new client situation I'm beginning to research, and would like some input if anyone wants to weigh in and if the following is enough info.

The dad wanted to retire and offered to sell S-Corp to his son.
Son bought 100% of the stock in the S-Corp from the dad for $300K.
Purchase price appears to be close to FMV of the business.
The purchase agreement specifies that the son is personally liable for the note.
Currently, the note calls for payment of interest only at 7% APR for up to 5 years.

In the first two years the interest payments of $21K have been made by the S-corp directly to the dad. The son works full time in the business and received about $100K in direct salary from the S-corp. The S-corp showed a loss in the first two years.

Any thoughts on how the $21K in interest payments should have been reported by the S-Corp and the son? (I know the dad reported it as interest income on his personal return).

[Bird Legs]

Interest paid by S Corp. for owner

Would not this be a receivable from the stockholder-owner, since the stockholder is the one legally liable?

[JoshinNC]

distribution to son

in your scenario the S-corp was making a de facto distribution to the son in the way of the payment of the interest. The S-corp can't be paying for the note itself because the S-corp didn't repurchase it's stock, the shareholder bought it. As such, the K-1 should have shown a distribution to the shareholder in the amount of the interest payments.

The even more pressing question is why did he take a salary and subject himself to SS and medicare when there was a loss. The IRS is not going to expect a business that is losing money to pay a salary to an involved shareholder (unless the salary is what caused the loss, then I would have gotten the salary to take the profit to $0 with the rest being a distribution).

[dsi]

Good advice from Josh.

[Davc]

Note though, that if the loss is financed by other borrowed money, you can't deduct interest on money borrowed to make distributions to the owners. You can deduct interest on money used for payroll.