100% owner of S Corp sales all stock to 2 new owners and issues a promissory note. The original owner retains interest in the land (transferred at closing). Land is distributed to owner at fmv (treated as a sale). Remaining S Corp assets and balances remain intact with 2 new owners. Prom note payments are made through the corp and coded to new owner distribution accounts.

Questions: (1)Does the original capital stock ($7000) and pd in capital account ($77000) get reduced with the distribution of the land?, or just leave them alone since the actual stock sale was between the shareholders?

(2)Also, is the S Corp supposed to issue the owners a statement showing basis (outside basis) since the information is available?, or does the S Corp just report the basis based on the transactions in the corp, and the new owners maintain their own basis records?

(3)Since there is a gain on the distribution of the land, seems obvious that the gain should pass through to original shareholder. Does the S corp need to make an election under Sec 1377 to treat the tax year as 2 separate tax years in order to allocate the gain 100% to original s/h? And, if so, can it still allocate the other ordinary income on a pro rata basis?

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First, I would caution you that unless you handle this with agreement of all parties you could be sued as the result will be different depending upon your decisions.

Second, you must establish facts as far as what steps happened in what order:

OldJack question: 1) You say the stock sale was to individuals, yet a promissory note was issued from the corporation due to the old shareholder?

OldJack question: 2) Or is it the old shareholder owes the corporation for the land? If so why would note payments go thru the corporation to the new shareholders?

OldJack question: 3) Was the sale (distribution?) of land to the old shareholder before or after the sale of shares of stock?

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>>Your Questions: (1)Does the original capital stock ($7000) and pd in capital account ($77000) get reduced with the distribution of the land?, or just leave them alone since the actual stock sale was between the shareholders?<<

Answer 1: The sale/distribution of land results in a taxable gain for the S-corp and as such increases the AAA account (a sub account of Retained Earnings account). The AAA account/Retained Earnings account does NOT belong to any specific shareholder like a partnership capital account does. It belongs to all shareholders at whatever time distributions are made.

>> Your Questions: (2)Also, is the S Corp supposed to issue the owners a statement showing basis (outside basis) since the information is available?, or does the S Corp just report the basis based on the transactions in the corp, and the new owners maintain their own basis records?<<

Answer 2: There is no requirement that any shareholder be given a statement of anything. Since a one owner signs the 1120S they should know their inside and outside basis. Of course it would/could be a nice thing for a preparer to calculate the basis for the shareholder, but realize if you make a mistake you could be sued.

>> Your Questions: (3)Since there is a gain on the distribution of the land, seems obvious that the gain should pass through to original shareholder. Does the S corp need to make an election under Sec 1377 to treat the tax year as 2 separate tax years in order to allocate the gain 100% to original s/h? And, if so, can it still allocate the other ordinary income on a pro rata basis?<<

Answer 3: The fair thing in a sale of S-corp stock is to elect to treat as 2 separate tax years (but only one tax return 1120S is filed) , close the books and "ALL" income and expense is allocated to the selling shareholder on his 1120S-k1 at year-end. In that method if the sale/distribution of the land was considered (at least a minute before) the sale of stock the gain would pass on the 1120S-k1 to the old shareholder. That is the fair way to treat the transaction. If this is the case the old shareholder should take distribution of all of his AAA account before the sale of stock and apply against the amount due for the land.

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Thanks, this all makes since.

The "purchase and sale agreement" is between the old s/h (seller) and the 2 new s/h's (buyers). It states - "whereas, seller is desirous of selling and Buyers are desirous of buying A Company....."

"Assets to be purchased: All outstanding stock, all assets shown in exhibit...."

"Parties agree that seller shall retain the real property..... parties agree that company may convey this property to seller prior to or on date of closing...." - so looks like seller is selling stock but retaining the real property which I think would be a distribtuion (sale) at fmv.

Agreement says that purchase of company will be payable... The "Buyers' payment obligation shall be memorialized by a promissory note..." This tells me that the note is between the shareholder and the seller (s/h).

So looks like I would distribute the land to original s/h and clear out equity accounts with distributions. However, the seller is not taking full distribution of accumulated earnings. So, this means that the seller would have basis in the stock left over to reduce gain on sale of stock. Looks like seller would report this on his tax return. I guess the left over AAA or capital left in company would remain in the corporation equity account.

Thanks for any additional comments.

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Yes.. the sale of land would be reported on the seller's 1120S-k1 and it then goes on his 1040. The seller then reports the sale of his stock on his 1040, Sch-D or form 6252.

The confusing think to me is the promissory note from the buyers and how is it to be paid to the seller. It would appear that the seller has an installment sale on the shares and would report it on form 6252 attached to form 1040.

>>"Assets to be purchased: All outstanding stock, all assets shown in exhibit...."<<

Not sure if they are only buying the stock or are they buying assets of the corporation instead? Maybe only stock and just specifying assets that the seller can't distribute from the corporation?

You really must investigate further to make sure you don't misunderstand something.

edit: the $7,000 stock issued amount can't be reduced or distributed since the shares of stock are not being redeemed or canceled.

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Yes, the entire contract was confusing. I have seen this before. I think that business owners and buyers just do not realize that there is a difference between a stock purchase and an asset purchase. They think they are one in the same, and further I have actually seen it written this way by the attorney preparing the contract. Then, to further confuse the issue, the company actually makes the payments for the stock.

Promissory note - It is supposed to be paid in monthly payments with interest. Of course, the payments are actually coming from the company and they are coding them to distributions. I have suggested that they increase their salaries and make the payments personally.

I concur that the seller should be able to report it as an installment sale.

Thanks for the add'l insite.

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>>Of course, the payments are actually coming from the company and they are coding them to distributions. <<

Since the corporation is not getting a deduction for distributions its not like it is a S-corp tax issue. However, if the 2 new owners are not equal owners the direct distribution to the seller would cause an unequal distribution that would therefore be classified as a second class of stock disqualifying and terminating the S-corp status.

Obviously, there is no problem with the 2 shareholders taking distribution if there are earnings to distribute, otherwise they could have a deemed sale of stock with a taxable gain to report on their 1040 Sch-D.

It would be much cleaner if the 2 new shareholders took distributions and then personally paid their debt to the seller.

Another issue is who is getting the deduction for interest paid. If the corporation pays it cannot claim the interest expense since it does not owe the debt. The 2 new owners can't claim the interest expense since they did not make the payment.

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