S Corp Liquidation

Okay, so I'm about 68.4% confident that I have the treatment of the following facts correct, but I'm hoping someone can get me closer to 90 to 100%, whether it be in my treatment or a more correct version .

Here's the situation:

2 S Corp owners - 50/50 ownership. Company has had losses for its first three years of existence and is now being dissolved. Shareholder A has loaned the company $50K, against which he has taken $15K of losses over the years (i.e. $35K of remaining debt basis).

Shareholder B has loaned the company $30K, against which she has taken $15K of losses, leaving $15K of debt basis.

The assets to be distributed at liquidation are $5K of cash and 2 books of business - 1 originally purchased for $45K, now with a net book value of $35K. The other was generated by the S Corp, so $0 basis. The books have a FMV of $30K and $20K respectively. Book retained earnings is (-$40K).

Let's say in liquidation, A is to receive $5K of cash and the 2nd book of business ($20K value) and B is to receive the $35K book.

As I"m typing my confidence level is dropping....about 22.3% right now.....

A receives $25K (FMV) in liquidation, and debt basis of $35K. He has a capital loss on liquidation of $10K??

B receives $30K (FMV) in liquidation, with debt basis of $15K. Does she have a capital gain of $15K at liquidation?

And I assume the debt needs to be converted to APIC, right?

And I assume the debt needs to be converted to APIC, right?. Don't think so.

I'm going to take that to mean the rest of the analysis was correct? Thank you!

Did not evaluate the rest.

OK, we need you to confirm some facts.

A and B each have a zero tax basis in their stock?

Corp. was never a C corp., right?

Do you have the history of the negative retained earnings of (40)?

Have you tracked AAA?

Have you considered the tax effects of the requirement to recognize upon liquidation the inherent tax gain of 20 on book number 2 and the inherent tax loss of (5) on book number 1?

Correct on stock basis, unless we convert loans to APIC. But yes, as of right now, they've dipped into debt basis in order to take losses, so Zero stock basis is correct.

Yes, I have a history of the $40K of negative RE. 2016 net income of $500. 2017 net loss of 18K, 2018 net loss of $21.5K. No distributions ever taken.

EDIT: I forgot to mention, yes this entity has always been an S Corp. Never a C.

Yes, I've tracked AAA since inception. With no distributions ever taken, it is also negative $40K.

Your last inquiry is the crux of my question. I'm trying to understand the impact. Are you suggesting the net gain would be $15K at the S Corp level? Some quick research leads me to believe that's the case.

So, if that's correct, we report the gains (treated as though S Corp sold the assets to the shareholders). The S corp would have a net $15K gain on the deemed sale of the 2 books, which would be allocated 50/50 on the Shareholder K-1s.

The next part is tying me up in knots, but I want to makes sure this is the proper treatment to this point?

Bear in mind, I don't believe we're even talking about distributions. These assets are being used to pay back the loans from the shareholders. As such,are we required to have the same deemed sale we would have with a distribution?

Are you suggesting the net gain would be $15K at the S Corp level?. Yes.

So, if that's correct, we report the gains (treated as though S Corp sold the assets to the shareholders). The S corp would have a net $15K gain on the deemed sale of the 2 books, which would be allocated 50/50 on the Shareholder K-1s.
. Yes, payment of a liability with an appreciated asset and an asset that declined in value, net 15.

But the tax basis of each shareholder gets increased by half of the 15.

And is the 15 an ordinary or 1231 gain at the corporate level?

And how does section 267(a)(1) enter the picture?

Thanks for the confirmation. And good questions.

I think the old book is simply a 1231 loss. Clearly it was a depreciable asset held more than 1 year. The book developed over the last 3 years? I don't know the answer to that question. I would imagine it would be 1231 gain, but even if true, would it be long-term or short-term? I don't know.

267(a)(1) entered my picture right now . I'll review, but at first glance, it appears you're just referring to the imputed interest portion of the payment, right?

But the tax basis of each shareholder gets increased by half of the 15.

I understood this as well. I mentioned it in the convoluted response I had drafted before I edited it down . Thanks.

Interestingly enough from TaxThisRight's thread a few down, there's this snippet Jeff-Ohio presented on their discussion on whether self-created Goodwill should receive Long term Capital Gain Treatment

From Charles H. Girt, TC Memo 1961-286, 10/16/1961

Our interpretation of the agreement is that there was the sale of an existing practice which Girt had built up over a period of some 15 years. We consider it immaterial whether any of the individual agreements were entered into less than six months before the sale. The petitioner is entitled to treat the proceeds as long-term capital gains.

I think it would follow that unless the book of business I'm discussing here was created entirely in less than 12 months from the sale (it wasn't), it should be treated as Long Term 1231 gain.

Or would section 1239 rear its head? Depends.

267(a)(1) entered my picture right now . I'll review, but at first glance, it appears you're just referring to the imputed interest portion of the payment, right?. No, the loss. But, it depends.