S-Corp reclassification of loans

[ILLMAS]

Scenario: Father and son (50/50) opened a business with each $1000 in paid in capital 15yrs ago, within the first of operation the father decided to move to another state to enjoy the nice weather, the son was 100% in charge of the business and would give the dad his k-1 every year.   The business pretty much operated at a loss every year and the son loaned the business close to 100K to cover the losses, for 2019 there is someone who might be interested in buying the business, can the son reclassify loan to additional paid in capital (50/50) to try to break even?

Father Paid in Capital $1000.

Basis negative 50K

Son Paid in Capital $1000.

Basis negative 50K

Son knows the father will not have money to pay the tax on the negative basis when they sell the business, and is willing to give up a portion of his loan as additional paid in capital to the father and reclassify his loans as paid in capital as well.

[Lee B]

Then in reality, the son is making a gift to the father.

File the gift tax return and go ahead.

[ILLMAS]

There is always a catch, I hate when that happens, but you are right I wasn’t seeing the other side as to the gift.

Thank you

[DANRVAN]

On 3/7/2019 at 4:51 PM, ILLMAS said:

Scenario: Father and son (50/50) opened a business with each $1000 in paid in capital 15yrs ago, within the first of operation the father decided to move to another state to enjoy the nice weather, the son was 100% in charge of the business and would give the dad his k-1 every year.   The business pretty much operated at a loss every year and the son loaned the business close to 100K to cover the lossesl.

Has the son's debt basis been reduced by pass-though losses?  Is the potential buyer looking at buying the corporation or the assets of the corporation?

[ILLMAS]

No, it was always the intention for the business to do well and recooperate the loans after profits, there are some assets but the potential buyer is interest in the shop for its location and existing customers.

[DANRVAN]

1 hour ago, ILLMAS said:

No, it was always the intention for the business to do well and recooperate the loans after profits, there are some assets but the potential buyer is interest in the shop for its location and existing customers.

Are there suspended losses?  With the history of losses it seems son would have taken losses against his basis in the loan.

 

On 3/7/2019 at 4:51 PM, ILLMAS said:

Son knows the father will not have money to pay the tax on the negative basis when they sell the business, and is willing to give up a portion of his loan as additional paid in capital to the father and reclassify his loans as paid in capital as well.

How would the overall tax picture look if son paid dad's taxes instead of increasing his tax liability.   Maybe keep son in  lower tax bracket and make best use of dad's deductions?   Also might eliminate the need for filing a 709.

[ILLMAS]

20 minutes ago, DANRVAN said:

Are there suspended losses?    This is going to sound funny, but I don't prepare their personal tax returns, son is going to look into that, he has found some old returns and from the numbers he has given me, they 100% match the copies of the K-1's I have.  With the history of losses it seems son would have taken losses against his basis in the loan.  I was thinking the the loans had to be reclassified to paid-in-capital to bring the basis to zero, if this is another option, the son will zero out, but the father no.

 

How would the overall tax picture look if son paid dad's taxes instead of increasing his tax liability.   Maybe keep son in  lower tax bracket and make best use of dad's deductions?  Just by the conversation, the fathers' only source of income is social security, which I will assume he is not paying any taxes, vs the son, he has other sources of income besides the business, so the father probably would be a lower tax bracket and he lives in a state without any state tax.   Also might eliminate the need for filing a 709. 

Also, the business is not going to sell tomorrow, the buyer is looking into maybe two-three years from now, however the son, now is considering changing his ownership to 99% and 1% for the father and if the business sells, for the father to receive 1% of the profit/loss and to prevent his basis from increasing in case the business continues to operate at a loss.  What will be required  if the son wants to return the dads paid in capital to leave him at the 1%?  The PIC will remain at $2K.

Thanks

[DANRVAN]

43 minutes ago, ILLMAS said:

Just by the conversation, the fathers' only source of income is social security

So if father is married, there is 24,000 of standard deduction to apply.  Also a portion of the gain would receive zero capital gains rate!

Son should be informed of how much could be saved if he was to pay dad's taxes (which could be minimal) vs gifting stock and increasing his own liability; provided he has basis left in the loan to convert.

Sounds like there is land owned by the corp that buyer is interested in, most likely would buy the land from the corp instead of buying the stock?

Also consider dad's health and age.  If there is appreciated property in the corp son could receive a stepped up basis in dad's share of stock.