Loss form Shareholder Buyout

[Terry D EA]

Shareholder from an S-Corp decided to leave the S-Corp. The shareholder  stock basis was 2475.00. The S-Corp experienced a loss of 13K in 2016. So, my client reported the 2475.00 loss on his 2016 tax return. No remaining basis to carry the loss backward or forward. The shareholder originally contributed 9k which should have been his cash basis in the S-Corp. I can't see the books of the S-Corp so I have no idea of how the S-Corp shareholder basis was tracked. The cash investment did not show on the shareholder's basis worksheet for 2016 just the stock basis. The separation agreement stated the shareholder (my client) was to receive the 9k from the S-Corp but only received 6k. My client attempted to collect the remaining 3k and was unsuccessful in doing so. So, can the loss of the 3k be claimed as an ordinary loss reported on form 4797? Any help will be appreciated. 

[Terry D EA]

Here is my take on calculating the basis:

1. Original contribution 9,000.00

2. Stock basis                 2,475.00 (I do not know where this came from. This was reported on the basis worksheet with the K-1 for 2016

3. Total  basis               11,475.00

4. Loss taken in 2016     2,475.00 (reduction in basis leaving the original 9k in basis. Shareholder voluntarily wants out. Agreement in place to return the remaining basis/capital. However, S-Corp never pays the full amount. S-Corp pays 6k leaving 3k that goes to form 4797 as an ordinary loss. Any suggestions???

[DANRVAN]

Terry, the information in your post is not clear to me.

-How do you know his original basis (contribution) was not reduced to $2,475 over the years?

-It appears basis of $2,475 was reduced to zero in 2016.

-In 2017 he received $6,000 for exchange of stock which now has a basis of $0...?

-I don't see how he can take a deduction for $3,000 proceeds he never received from the sale of stock  The unpaid balance was never included as taxable.  

 

[jklcpa]

I agree with Dan, and I am also wondering about some of the data in your post.  In an S corp, there isn't a basis called "cash basis" separate from "stock basis".  The owner's stock basis in an S corp is the original investment of cash and property that the owner contributed to the entity in exchange for the S corp stock. There could be "debt basis" also if some of the funds put in were loaned to the S corp, but you didn't mention anything about debt basis, so for purposes of this discussion, the entire amount initially invested is this owner's starting stock basis. 

The stock basis is adjusted each tax year by items of income and expense on the K-1, plus additional capital contributions, less distributions, generally speaking. There's are specific order and more detail rules, but that is the general idea.  Think of it as keeping a running total in a checking account with the initial starting balance as the investment, then each year making +/- adjustments for those items I mentioned, so that at the end of each year the stock basis is a new number, never going below zero. 

From what you said, over the years this owner's stock basis had been reduced from its original investment down to $2,475 at 1/1/16.  With his share of the 2016 loss exceeding his starting basis, he was able to deduct the the loss up to remaining basis, and that loss took his basis to -0- at 12/3/16.

Has your client received a K-1 with activity for 2017?  Was his 2016 K-1 marked as "final"?  That may make a difference in your reporting if he had any share in income for 2017.  What was the date of his stock redemption?

 

[BulldogTom]

Just a point of bookkeeping clarity.   Some of us (me) will keep 2 equity accounts for each shareholder of a small S Corp.   The first is the "Paid In Capital" or the initial investment of the shareholder to purchase the stock.   I never post to that account again.   The second equity account is the "Shareholder Retained Earnings".   I post all of the distributions for each shareholder during the year to this account.

Then there is the running retained earnings account, to which all of the profits and losses of the company are posted monthly during the year, without any breakout by shareholder.   At the end of the year, I close this retained earnings account to the shareholder's individual retained earnings accounts based on their ownership percentages.

To get the "true" basis for the shareholder, you need to combine both shareholder equity accounts.   

I know, it may sound incorrect to do it this way, but I like to keep the initial investment clean in the balance sheet.

This may have provided no insight at all to Terry, and I apologize if I am muddying the water.

Tom
Modesto, CA

[grandmabee]

So if his basis is zero after taking the 2016 loss on K-1 wouldn't the 6000. be a gain on his tax return for sale of stock with zero basis?

[Terry D EA]

11 hours ago, jklcpa said:

I agree with Dan, and I am also wondering about some of the data in your post.  In an S corp, there isn't a basis called "cash basis" separate from "stock basis".  The owner's stock basis in an S corp is the original investment of cash and property that the owner contributed to the entity in exchange for the S corp stock. There could be "debt basis" also if some of the funds put in were loaned to the S corp, but you didn't mention anything about debt basis, so for purposes of this discussion, the entire amount initially invested is this owner's starting stock basis. 

The stock basis is adjusted each tax year by items of income and expense on the K-1, plus additional capital contributions, less distributions, generally speaking. There's are specific order and more detail rules, but that is the general idea.  Think of it as keeping a running total in a checking account with the initial starting balance as the investment, then each year making +/- adjustments for those items I mentioned, so that at the end of each year the stock basis is a new number, never going below zero. 

From what you said, over the years this owner's stock basis had been reduced from its original investment down to $2,475 at 1/1/16.  With his share of the 2016 loss exceeding his starting basis, he was able to deduct the the loss up to remaining basis, and that loss took his basis to -0- at 12/3/16.

Has your client received a K-1 with activity for 2017?  Was his 2016 K-1 marked as "final"?  That may make a difference in your reporting if he had any share in income for 2017.  What was the date of his stock redemption?

 

Just to clear things up a bit. This was and is a restaurant business that both parties entered into equally in 2015 and did not get opened for business until Jan 2016. So, no years of basis increase or decrease only one year. Each party contributed 9k cash. I am fully aware of the what comprises the basis. What I don't know is who determined the stock basis was equal to the 2475 when it should have been the 9K. He has records, receipts and copies of the original agreement and the departing agreement. The K-1 from 2016 was not marked as final. No he has not received a K-1 for 2017. The parting agreement was to repay him the 9k he invested. Yes, this is in writing. He only received 6K which leaves the 3k balance. My client was told he would not receive the 3K as the guy refused to pay him based on a rumor that he was talking poorly to someone about the business which was part of the departing agreement. So,  he attempted to sue in small claims court. His attorney advised against it due to the fact it would cost more or just as much in attorney fees, filing fees and aggravation so he dropped the law suit.

If I look at the whole picture. In 2016, the K-1 shows a loss of 13K for my client. Due to their basis calculations, he could only take the 2475 as a loss because that is all they reported as his basis on the basis worksheet. My client reported that loss on his 2016 tax return which leaves 6,525 that he should have been able to take in subsequent tax years until all loss had been used and had they reported his basis correctly. He received 6,000 which leaves a loss of 525. That amount is what I really feel is the loss. However, there is the departing agreement that states he was to receive the 9K. Also, if he would receive the full 9K, it would appear he would have 2475 to report as taxable income. What a mess!

I don't know who did the accounting for this business and I don't want to know. Yes, the shareholder should track his basis which he did which is also why we have this discrepancy. For 525.00, I say cut your losses and move on. But, can I ignore the departing agreement. 

[Lee B]

You don't mention, a. the date of the separation agreement, b. whether the restaurant operated in 2017, c. whether your client has a 2017 K -1 coming ?

[Terry D EA]

Client is not receiving a K-1 for 2017. The separation date to the best of my knowledge was around May of 2016. The separation agreement was signed on the day of separation. Yes, the restaurant is still in operation.

[DANRVAN]

6 hours ago, Terry D said:

Just to clear things up a bit. This was and is a restaurant business that both parties entered into equally in 2015 and did not get opened for business until Jan 2016. So, no years of basis increase or decrease only one year. Each party contributed 9k cash. I am fully aware of the what comprises the basis. What I don't know is who determined the stock basis was equal to the 2475 when it should have been the 9K. He has records, receipts and copies of the original agreement and the departing agreement. The K-1  

Terry it looks like you have proof of the actual basis, so why not go back and amend 2016?

In regards to the  uncollected $3,000, he can not write if off since it was a capital contribution and not a loan.

Smells like a lot of bad blood developed in the deal, were they friends to start with?

[Terry D EA]

Thought of that but, if I amend 2016 to show the entire 9k loss, then there will be taxable income for 2017 for the 6K he received in 2017 correct?

[Lynn EA USTCP in Louisiana]

The $6k he receives in 2017 is capital gain. Yeah. The $9k loss in 2016 is ordinary income reduction.