1377(A)(2) Election Understanding

Technical topics regarding tax preparation.
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Need some help on an election and how much of a headache to make for my client.

49% shareholder was forced out of an s-corporation. The agreement identifies it as a sale of the membership interest with a closing date of March 13, 2022.

The "total purchase price" per the agreement was:
- $398k for minority membership interest
- $68k payment for seller's expenditures due after his "management end date" of 1/11/22 (these were all accrued expenses as of 12/31/21 or benefits owed through closing)
- $472k outstanding AR owed.

The CPA who prepared the K-1 elected a 1377(A)(2) closing of the books and filed a 1099-B reporting $398k in stock sale proceeds. The final K-1 reporting $472k (the AR) as box 1 ordinary income. The entity is cash basis.

My client wasn't allocated any of the operating expenses for the short period, and the K-1 lacks any QBID disclosures.

I had my client ask the CPA about it, and he was told "K1 expenses were not addressed because the K1 was based on solely on the sales agreement which is silent on the matter. I have nothing on the books for the short period because, again the sales agreement was the basis, for the Qualified Business Deduction. He said a 1377 election was used to support this buy out."

As I understand it that's not how the 1377 election works. He should get 49% of whatever NI was for that short period, and the buyout is a separate issue. They reported the AR payment as a distribution to him for 2022.

Their presentation with AR = OI results in about $60k more in Federal taxes than if it's AR = LTCG as either additional stock proceeds or excess distributions.

Does the sale agreement being silent about expense allocations mean he doesn't get any? And same with QBID? My understanding the 1377 election is he should get 49% of the NI for the short period.

To muddy it further, my client obviously didn't consent to the election. The per-share, per-day basis might also be the better outcome. He left 3/13 and the company lost it's major contract in June, so he suspects that had a significant decline in revenue.
 

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