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Lev, Tax Advisor
Category: Tax
Satisfied Customers: 29975
Experience:  Taxes, Immigration, Labor Relations
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I have a written contract that a shareholder of our S-Corp

Customer Question

I have a written contract that a shareholder of our S-Corp was paid $106,000 as a buyout. The shares he was allotted are only worth $100, so the remaining amount was strictly paid as a buyout price. Are these payments a deductible expense to the company and how do I report them on his K-1?
Submitted: 2 years ago.
Category: Tax
Expert:  Lev replied 2 years ago.
Hi and welcome to our site!When shares are repurchase by the corporation - they become "treasury shares" - these are shares owned by the corporation - these shares are IGNORED purposes as if they were not existed.How the corporation will use these shares later - is not important - they may be awarded to employees as compensation, sold to investors, etc.The shareholder who sold shares will report the sale transaction on his tax return as (selling price) MINUS (basis) = (capital gain)The corporation may NOT deduct the purchase price - that is capital expense - and "treasury shares" will be on the balance sheet as capital asset.That amount is NOT reported on K1 - and that is not income for the corporation - but that information is provided on attached note to K1 shareholder.When the corporation sell these shares - it will recognize capital gain or loss based on the selling price.
Customer: replied 2 years ago.
Yes I understand that regarding the shares. It's the remaining $105,900 that the company paid to him. Would this be classified as a "guaranteed payment" as defined by the IRS? How do I record this payment on the company's books?
Expert:  Lev replied 2 years ago.
That is NOt a "guaranteed payment"
Guaranteed payments are used by partnerships - not by corporations -
Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income.
Generally - that is a payment for services.
In your situation - a payment for shares - is NOT a "guaranteed payment" and is NOT reported on K1.
Expert:  Lev replied 2 years ago.
For the corporation - that is a capital expense - and "treasury shares" will be on the balance sheet as capital asset.
How to record that purchase on books - see here
scroll down to "Treasury stock"
Let me know if you need any help.
Customer: replied 2 years ago.
This is now the third different answer I've received for this scenario. I've been told by an accountant that this should be applied towards Goodwill, and on your site, JD previously answered a slightly different version of this question with an entirely different answer. The only difference in the circumstances of that question and mine was that that shareholder got sick and was no longer able to work. I'm just trying to make sure I'm doing this correctly on our 1120 - S and I'm beginning to believe there's no true right or wrong way to do this.Keeping in mind his shares are only worth $100, as reported on all preceding 1120s, won't this large transaction look suspicious to the IRS if all of a sudden I'm saying his shares are now worth $106,000?Again if I expense it as Treasury Shares, how do I report this on the former shareholders K-1?
Expert:  Lev replied 2 years ago.
I am not sure what you asked previously and what answers you received.
That was not a part of our discussion.
If you pay to the employee for services or for retirement - that is compensation and taxable income for the payee.
Guaranteed payments are used by partnerships - not by corporations.
In case you have a corporation - the compensation mainly is treated as wages - not guaranteed payments.
If that payment $106,000 - is NOT for shares - but partially for shares and partially a compensation - you need to separate that amount - and treat each part differently.
Compensation for services is reported on W2 and purchase price for shares is NOT reported on neither W2 nor K1.
K1 ONLY reports shareholder's share of corporation's income and deduction items.
All other information including the transaction for repurchase shares is reported on attached statement - and not directly on K1.
When you previously reported that shares are worth $100 - that is not the fair market value - but capital contribution - which is treated as purchase price or the basis for the shareholder.
When the shareholder will report the disposition of shares on his/her tax return - the gain will be calculated as (selling price) MINIS (basis)
To determine the actual value of shares - we need to appraise the corporation itself - and that would be the fair market value - then divide that value by the total number of outstanding shares - and you will have the fair market value of each share.
If your repurchase price is different from that FMV - you would need to have an adequate explanation.
In the ideal situation - that FMV would be equal to your purchase price $106,000.
If the FMV of shares is much less - then we need to be clear - only a part of that amount is to repurchase shares and another part is paid for other reasons.
I hope that helps.