Thanks for getting back to me.
Here is the problem I have. Even though she abandoned the company, she may still have a tax liability.
I do not know the terms of any agreement or contract between you. BUT from an IRS perspective, she would still be receiving a K-1 for the tax year in which she walked. (at least).
legally if she did not formally transfer shares to you, she still owns them. She can abandon the share by gifting them back to the S-corp, or selling them back, to the S-corp, or selling them or gifting them to someone else according to the terms of the S-corp. Most S-corp shares are close hold and can not be sold to persons outside the S-corp.
If she is forgiven a loan, then that forgiveness of debt can be considered taxable income to her.
But the corporation and remaining share holder(s) will assume the entire loan and any obligations stemming from that.
1377 election simply means to me that the shares she gives back or sells back (turns back) to the corporation become divisible by the remaining share holder(s).
There has to be some indication of this action besides simply walking away.