S-Corp redemption

I am working on an S-Corp final year return with a prior redemption and I think I am missing something conceptually.

1) Corp was originally a C-Corp with 10 shareholders @ 10% each. Capital stock on the BS was $100,000.

2) In 2010, the corp redeemed 9 of the shareholders for $250,000. BS now shows common stock for $100,000 and treasury stock for ($250,000). The treasury shares were not reissued.

3)The corp converted to an S-Corp in 2011 with the one remaining SH.

4) Corp liquidates in 2019 and SH has zero basis prior to liquidation. For sake of simplicity, assume there are no other assets or liabilities at the time of liquidation. It appears that the liquidation with the treasury stock is creating a gain for the SH. Part of me thinks that isn't right and part me thinks it is because he went from owning 10% of the corp to 100% with no taxable event to him.

Am I completely missing something here?

How can there be no other assets or liabilities, even just for simplicity? 250 treasury stock, 100 capital section, and what else? Give us a simplified balance sheet immediately before the liquidation. Are you saying we should assume no distribution on liquidation? What does the AAA account look like? And the retained earnings account, i.e., accumulated E&P from C corp. days. The cash for the 250 redemption had to come from income or debt.

Balance sheet before liquidation:

Cash - 97,592
Common Stock - (99,863)
Treasury stock - 232,842
RE - (230,571)

AAA is (121,930)

The redemption in 2011 was funded out of income.

Remaining cash will be distributed to sole SH upon liquidation.

Got it. So I gather your concern is whether the 232 in Treasury Stock will be viewed as an asset taxed to him upon liquidation. No, it won't. Assuming in your facts nothing else of value (goodwill, e.g.) is in the corporation, his gain will be his basis compared to the cash distributed.

I think you're way past the BIG recognition period.

https://www.thetaxadviser.com/issues/20 ... corps.html

Got it, thank you.

It appears that the liquidation with the treasury stock is creating a gain for the SH.

So, the guy will receive $98k in Cash (as per Post #3), he has no stock basis, so he’ll have a $98k gain…why doesn’t that seem right to you?

It appears that the liquidation with the treasury stock is creating a gain for the SH.

So, the guy will receive $98k in Cash (as per Post #3), he has no stock basis, so he’ll have a $98k gain…why doesn’t that seem right to you?

I understand the gain on the cash distribution. I was thinking (overthinking) about the mechanics of the previous redemption. I was thinking that since his ownership went from 10% to 100% solely by the dilution of all the other SHs, and the remaining shareholder had no economic outlay or taxable event for his ownership increase, he would have to show income for that on the liquidation. But as Nioldop said above, that is not the case.

I was thinking (overthinking) about the mechanics of the previous redemption. I was thinking that since his ownership went from 10% to 100% solely by the dilution of all the other SHs, and the remaining shareholder had no economic outlay or taxable event for his ownership increase, he would have to show income for that on the liquidation.

It’s a good thought. Let’s follow it through…let’s say we have a corp with 3 equal shareholders. Corp value is $200k in cash and $100k of intangible value. So, the value is $100k per shareholder. Two of the shareholders get redeemed out for $100k apiece. All $200k of cash is used. With respect to the guy that stuck around, he had $100k of value before the transaction (1/3rd of $300k) and $100k after (100% of $100k). There has been no shift in value.

Yes, as you observe, your guy’s ownership did increase…but the overall enterprise value decreased when corporate assets were used to fund the redemption. In the end, your guy gets a higher ownership percentage, but applied to a lower overall value. Same would hold true if the $300k enterprise value was entirely intangible and the entity borrowed $200k to fund the redemption. In that case, your guy would be stuck with: Gross enterprise value of $300k, but then we’d minus off the $200k of debt, to arrive at net enterprise value of $100k.

Thank you Jeff! It makes perfect sense. Sometimes it is easier to slow things down and play out a simple scenario like this. That is where a lot of answers are found.