Thanks, Pitch. I think where we’re ending up is here: We’re going with the language in the agreement as written. This means we’ll use an enterprise value of $71,429 (70% of which is the $50k). Starting point for Key Employee’s income inclusion would be the $21,429. We plan on lobbing off 25% as a minority interest discount. This would make the EE’s income inclusion $16,072. Corp would get a deduction for that, which we’ll allocate entirely to the selling shareholder under Sec 1377(a)(2). We’ll also get the Key Employee’s consent as to the 1377(a)(2) election, which shouldn’t be a problem. We already have the consent of the selling shareholder and the cash buyer shareholder. The corporation will issue a 1099 to the Key Employee, which is the best we can do at this point without a lot of hassles.
Then there is the liquidation to deal with…as stated, the cash buyer (primarily) and the Key Employee basically shut down this corporation they just acquired and started operating as a newly formed LLC (taxed as a partnership). I think this is a taxable liquidation involving a corporation with value. In computing inside value as to the S-corp liquidation, we plan on using the $71,429 (no discounts available on the inside). This will produce entity level gain, that will pass thru exclusively to the new 70% shareholder and the 30% Key Employee, as per the (a)(2) election.
My client, who no longer owns the S-corp, is spear-heading all of this, including the handling of the 1120S. He is worried that since his name and address are attached to this corporation, something might come back to bite him if things aren’t done right….although he could say: “I’m not the owner anymore. You new owners figure it out and just send me my K1.” But he doesn’t want to leave the 30% guy, who is also a friend of his, and a young kid, in the lurch. I should add that the 30% guy is in charge of everything at this point. The 70% cash buyer fell ill and is on her deathbed. When she fell ill, she transferred her 70% equity to the Key Employee, which the Key Employee apparently accepted.
I did advise my client to think hard about his role in all of this. It might be in his best interests to just tell the Key Employee, “Just give me my K1” and leave it at that. Even though the Key Employee has authority to sign the 1120S and make decisions surrounding it, I wonder how the heirs of the 70% owner will feel when they get a K1 with a big gain on it from the liquidation. They won’t be happy and they might be looking to place the blame on someone. In addition, my client doesn’t want to leave this mess to the young Key Employee to figure out on his own.
I also told my client that the 2018 Form 1120S doesn’t have to marked “final.” Even though a Newco was formed, one might argue that Oldco wasn’t liquidated, and Newco is just using the Oldco assets on a rent-free (or royalty-free basis). I doubt the IRS would see it that way, however. One issue with keeping Newco alive is that my client can’t get comfort around this entity still hanging out there, with his name still attached to it, when the thing could be shut down and a final return filed.
I think my client’s IRS concerns are unwarranted. Overall, I think he’s worried because this sale happened in 2018 and he was the 100% owner on the last tax return filed (and an owner for part of 2018). IRS has his name, address, etc. Things have not been transitioned over to the new owners such that client is off the radar. So he somehow thinks the IRS will connect things back to him. From a legal standpont, it’s not making much sense to me. I don’t think he has any responsibility here, in terms of the 2018 Form 1120S filing, even though he was a shareholder for part of the year. But it’s been a while since I’ve researched the issue. I don’t think the IRS can deem a former shareholder as responsible for filing the return, but I could be wrong. But at the same time, I understand where he’s coming from in terms of not wanting to leave the the Key Employee in the lurch. Even if client can deflect the IRS, they’ll be coming for the Key Employee next. And client doesn’t want that either.
But no, there's a deemed capital contribution and transfer of the shares by the corp.
A deemed capital contribution of what – cash? If so, that means the selling shareholder would have a stock basis increase for the amount of compensation recognized by Key Employee (and deducted by the corp), right?