TaxProTalk.com

I wanted to bounce this off the board, new client, here is the situation:

-C-Corp - 3 equal shareholders (individuals)
-They are taking small W-2 wages. However, they have been taking distributions for additional income needs for 20+ years and booking them as loans from the corporation to the S/H's.
-S/H A has a $120,000 loan balance, S/H B has a $40,000 balance, and S/H C has a $130,000 balance.
- S/H's A & B want to be bought out by an outside party, C wants to keep working. Neither have the cash available to pay back the loan.
-Value of the shares is roughly $600,000, $200,000 per 1/3 shareholder.

Trying to figure out the cleanest/best way to structure the buy-out of A & B. Initial thoughts...

Corporate Stock Redemption: Corporation buys the stock from A & B, the outstanding loan balances reduce the payout on the stock buy-out. Redeemed stock reissued to new shareholder. The loans are off the company books right away seems like the plus on this end.

or

New Investor buys out the stock directly from A & B (but likely with a promissory note) - as the old S/H's receive payments, they pay back the loan balance.

My main question: I'm looking for pitfalls in either strategy that I might be missing?

Watching. The trouble is, they ran it like it was an S corp instead of a C. They don't get those loans for free. I'm thinking there's either gotta be some divs or wages no matter what else you do. Now I'll see what others say....

If I'm the New Investor I don't want to buy in to this loan situation. I want them all paid off before I buy in.

I'd go with the first option but C has to pay his off, too and cease and desist in the future.

JR1 wrote:Watching. The trouble is, they ran it like it was an S corp instead of a C. They don't get those loans for free. I'm thinking there's either gotta be some divs or wages no matter what else you do. Now I'll see what others say....

That was my initial thought. Ultimately, there would be double taxation. The taxes already paid on earnings retained that were used to make the loans, and capital gains rates on the proceeds over the stock basis which I'm assuming is minimal.

No argument that it's been run incorrectly. My client is the employee that wants to buy out two of the partners.

Uh, that's the whole point of the C! Double tax.

I get that, I guess I was trying to point out that even if it didn’t get reclassified as wages or dividends, it’s still not escaping double taxation.

If it’s not going to cause an NOL problem, have the leaving shareholders pick up w-2 wages equal to the loans (have the loans paid off via compensation expense). No double taxation.

Exactly, unless they don't take the wages.....

Did they ever have any intention on paying back the loans? Were there even official loans written up?

I would be highly tempted to advise them to consult a lawyer about whether or not the C Corp should be bought out as an asset purchase, so that the new owners are not getting the carried over liabilities that would result if the IRS ever audited the old C Corp. The old C Corp should probably be closed down after sale of assets/Correction of treatment of booked "loans".

I just wonder how close it is to being criminal filing false tax returns/forms/understatement of income.

HenryDavid wrote:If it’s not going to cause an NOL problem, have the leaving shareholders pick up w-2 wages equal to the loans (have the loans paid off via compensation expense). No double taxation.

Good point, thank you.

Noobie wrote:Did they ever have any intention on paying back the loans? Were there even official loans written up?

I would be highly tempted to advise them to consult a lawyer about whether or not the C Corp should be bought out as an asset purchase, so that the new owners are not getting the carried over liabilities that would result if the IRS ever audited the old C Corp. The old C Corp should probably be closed down after sale of assets/Correction of treatment of booked "loans".

I just wonder how close it is to being criminal filing false tax returns/forms/understatement of income.

I have some concerns on this one as well and it's not even my client at this point (but likely would be if I want it). The tough part on the asset sale option (and being a C-Corp) is it's a machinery intensive business and that is where most of equity is in the business.