S Corporation Liquidating Distribution

Facts: S corporation with two owners, 50/50 ownership, decide to walk away from the corporation. Each has identified fixed assets that they are going to take and start their own new s corporations. One owner is taking assets that are mostly fully depreciated and have no basis but significant FMV - for example, work trucks that were written off but still have value. The other owner is taking assets that have not yet been fully depreciated. There are no other assets. Cash was spent to pay the remaining vendor bills. There is no debt.

Question: Is there a liquidating property distribution resulting in a significant gain to the corporation or is it a transfer of assets? If it is a liquidating distribution, is it possible to specially allocate the gain to each partner or does it need to remain 50/50? Any other considerations?

Liquidating isn't a great answer if there are assets where significant gain will be recognized. Why do both shareholders need new corporations, can't one of them withdraw and the other remain as the sole shareholder?

If one of the shareholders withdraws with minimal gain recognized, the corporation may be able to make a closing of the books election so he is only allocated income during his period of ownership. No other way that I know of to specially allocate income.

Can they make a tax-free reorganization and split the business into 2 S Corps (one existing and one new, or 2 new S corps if necessary)?

Can they make a tax-free reorganization and split the business into 2 S Corps (one existing and one new, or 2 new S corps if necessary)?

My thought as well, using 355 with or without 368(a)(1)(D). Some careful attention to compliance details needed, but not that overwhelming. Are there 2 separate businesses? Keep in mind all it does is defer the tax.

Unfortunately the parting of the ways took place in 2019 with the winding down of the original business in 2020 without consulting with me. This was a separation with one of the partners acting particularly ugly and doing some shady things where attorneys are now involved. Yes, the original and the subsequent two business are in the same industry. The original business was in operation for less than 5 years so I don't think using 355 was an option. The 2019 tax return has not yet been filed so there is some remedy regarding gain. One of the work vehicles was purchased in 2019 for 50K and we were going to fully write it off, however, under the circumstances, we can elect out of bonus depreciation. Is a special allocation of any gain an option?

OK, so a taxable liq'n is where they are. (Partnership would have been different result). No special gain allocation is allowed.

But aren't these true?
Each owner received equal deductions for the depreciation on each asset.
Each owner reduced outside basis in their stock equally.
Each owner will therefore report equal share of the liq'n gain and get equal tax basis in their respective assets.

Why is a special allocation needed?

The 2019 tax return has not yet been filed so there is some remedy regarding gain. One of the work vehicles was purchased in 2019 for 50K and we were going to fully write it off, however, under the circumstances, we can elect out of bonus depreciation.

If I understand your facts, aren't they subjected to the rule that you don't take ANY depreciation for an asset acquired and disposed of in the same taxable year?

Re post 5. Yes all those are equal. I think OP is saying the distributions (FMV of the assets distributed to each) are not equal.

If so, it's pretty unclear. He seems to me to be saying the basis of assets is unequal. Why would either s/h get more or less than 50%?

Thank you all for your replies to date. Some clarifications - The s corporation is winding down in May 2020. The work vehicle that was purchased in 2019 for 50K was not distributed until 2020 so it was not acquired and disposed the same year. The ethical questions is that the ugly partner took most of the assets. My client was just happy to be rid of him and allowed him to do so. That is why I asked about a special allocation of the gain in 2020. It does not seem fair that my client receive 50% of the gain when he did not receive 50% of the assets. That being said, if I do a special allocation and have uneven distributions would that not just result in a technical termination of the S corp, which at the end of the day will be dissolved anyway? Or does the technical termination go back to Jan 1, 2020? If so, then is the LLC now a C corp for 4 mths or a partnership? To make things more confusing but perhaps a better outcome, it looks like there were in business almost exactly 5 years. I will look into the 355 reorg, however, if we need any cooperation from the old partner, that will probably not happen. The two are not speaking and I would have no way of knowing his new entity type.

not sure what a "technical termination" of an S Corporation is - uneven distributions, particularly liquidating distributions, may not blow an S election (the concern with non- pro-rata distributions has to do with potentially multiple classes of shares, i.e. a right to uneven distributions). If "ugly" shareholder is essentially redeemed out at this point before non-ugly shareholder, this shouldn't be an issue at all (a distribution in complete redemption of a shareholder's interest does not have to be pro-rata with un-redeemed shareholders).

The good news is the "ugly" shareholder would probably still need to recognize gain on the liquidating distribution (since the FMV of the property received will exceed the basis increase from his share of the gain within the S Corp); the potentially bad news is that the non-ugly shareholder may get an increase in stock basis that will be a capital loss on liquidation. I think you need to run through the numbers to see if that's the case, or if it has an impact.

It looks like the business does qualify for a section 355 with 368(a)(1)(D) tax-free reorganization. I have not done one of these before and my research so far indicates that a PLR is no longer needed. It is recommended that fairly detailed records of the transaction are maintained in case it is ever challenged. I do not see any election forms, check boxes, or attachments required. Is that correct? Also, does an attorney now need to get involved to draw up a reorganization plan legal document?

I believe a statement is required for a tax-free reorganization, disclosing the parties to the transaction, the FMV, and the tax basis of the assets transferred.

An attorney would need to be involved for the corporate transactions (and formation of the new corporation(s)).

There are formal, i.e., administrative requirements, all in the regs. But much more importantly, there are substantive requirements in the Code and regs. Stuff like business purpose, not a "device", plan of reorg., etc. Some required before the spinoff/splitup.

One of the work vehicles was purchased in 2019 for 50K and we were going to fully write it off, however, under the circumstances, we can elect out of bonus depreciation.

You can't take any depreciation on a §1245 asset purchased and sold in same year.

The work vehicle that was purchased in 2019 for 50K was not distributed until 2020 so it was not acquired and disposed the same year.

It does not seem fair that my client receive 50% of the gain when he did not receive 50% of the assets.

My client was just happy to be rid of him and allowed him to do so.

I probably have not focused enough on the non-equal distribution of values. I wonder if the excess to the ugly guy is ordinary income to him and an ordinary deduction to the nice guy.