S-Corp- Bringing on New Owner options

Technical topics regarding tax preparation.
#1
CMBTax  
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Client A owns 100% of ORIGINAL S-Corp, in existence for 10 years. There are 100 shares outstanding (authorized 200k). He wants to bring on Client B as an equal into the S-corp. What are the best options of doing this?

1. Determine equity of S-corp per share, have Client B purchase 100 shares at the determined per share price, net effect is each own 100 shares.
2. Create a new PARENT S-Corp, which is owned 50%/50% by Client A and Client B. Have it elect for ORIGINAL S-Corp to be QSub.
3. Dissolve ORIGINAL S-Corp, create new S-Corp with new 50%/50% arrangement.

I handle quite a few single person S-corps, but I don't much experience with reorganizations and this has me confused.
 

#2
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This is not a one-size-fits-all transaction. Need more info. What's their deal? How much is Client B supposed to pay? What are the assets? What is A's transition plan, exit strategy?
Steve
 

#3
CMBTax  
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Client A is to remain operating the business does not plan on exiting. Client B has been a long-time employee that he is now wants to bring on as a co-owner. ORIGINAL S-Corp assets are minimal, $200k, $20k liabilities. They have no idea what Client B is to pay, they just want to be equal partners. Client A suggesting he removes $150k via distributions, so the S-corp only has $50k in assets and Client B has to pay in much less to be equal.
 

#4
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Uh, 4. Determine the VALUE of the company and new guy either buys for his share or is comped for it. Fairly common.
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#5
lckent  
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I don't see any reason to complicate it unless B is worried about unknown liabilities. Just have S corp issue stock to B. If you want to distribute to A before B comes in, that's OK. What they need to determine is the price for B's buy=in.
CPA, Retired
 

#6
CMBTax  
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OK, that makes sense. I think their worry is going to be when I say, "If you want Client B to have 100 shares, based on value of equity of company per BS he needs to contribute $180k" they will say "B doesn't have that $180k".

Then the answer to that would be "Client A distributes $150k cash to himself, Equity per BS in company is now $30k, Client B must now only contribute $30k to get 100 shares."
 

#7
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Correct. It doesn't make much sense to leave cash in the corporation.

You have to think outside the box, but with a little creativity significant income tax savings are possible, e.g., via an installment sale of all of the assets to a new entity (especially goodwill) comprised of B 50% and 50% by an unrelated person, such as A as trustee fbo an in-law.
Steve
 

#8
JR1  
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Equity has NOTHING to do with it. Stop using that term. Fair value.
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#9
CMBTax  
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OK, what is the best way to determine fair value then? One-person S-corp, $1mil rev, ~$250k profit.
 

#10
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Is present owner selling half of his shares, or is the plan for new owner to buy shares directly from the corp.?
 

#11
JR1  
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Same way you do for any business. Some sort of valuation, usually based on weighted cash flows. That's how stocks are or should be valued.
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#12
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What do they want it to be?
Steve
 

#13
JR1  
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Uh, sorry, that doesn't matter. If you've got 250k profit annually, tough not to start at 1 mil before adjustments, minority discounts, etc. whatever is allowable these days. Ask client A how much it would take to walk away with a check in hand....if he's yanking down 1/4 mil per year...it won't be much less than that. So new guy somehow needs to pay 500k give or take. Somehow. It is NOT whatever you want it to be, sorry, Steve.
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#14
CMBTax  
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Nilodop wrote:Is present owner selling half of his shares, or is the plan for new owner to buy shares directly from the corp.?


Plan is for the corporation to issue new shares directly to Client B.
 

#15
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I meant what do the clients want it to be? This question calls for a lot more information. It's not a problem that should be viewed in isolation.
Steve
 

#16
JR1  
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Again, if you're speaking to valuation, I strongly disagree as would all the case law.

If you mean about the arrangement, that's all up for whatever, indeed. But again, if they want to be 50/50....somehow or another B has to pay or marry A.
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#17
lckent  
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If B is allowed to purchase shares for less than FMV, it will be treated as compensation. I would get an appraisal, then decide how much B will pay and how much is compensation, if any. It will be expensive, but the tax and penalties incurred if sold at less then FMV and not reported as wages will also be expensive.
CPA, Retired
 

#18
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I would not get an appraisal. The clients know what it's worth and the IRS is not going to challenge their figure unless it is unreasonable.

Does Client A intend to keep control?

This thread is premature because we don't know what the parties are attempting to accomplish. Why does Client A want to bring Client B into 50% ownership? What is the exit strategy?
Steve
 

#19
lckent  
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Post #3 seems to indicate that sale is contemplated at book value, but it seems that goodwill was not being considered. I'm just saying that a sale below FMV, whatever that is, will generate compensation to B. I would prefer to nail down FMV.
CPA, Retired
 

#20
sjrcpa  
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What if there is a shareholder agreement that calls for buy in at book value?
 

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