Contact UsSub S with one shareholder formed in 2003 to develop and sell medical billing software. Sub S assumes all assets and liabilities of sole proprietor (founding computer programmer). 2003 1120S Schedule L included 1 item $43K in cash and $84K retained earnings and $110K revolving line of credit. (no the balance sheet did not balance) - Taxpayer gets audited for 2009 - the first year the tax practitioner puts the LOC on the books (when it was valued at $475K. IRS is asserting $475K is shareholder debt relief.
Sub S with one shareholder formed in 2003 to develop and sell medical billing software. Sub S assumes all assets and liabilities of sole proprietor (founding computer programmer). 2003 1120S Schedule L included 1 item $43K in cash and $84K retained earnings (no the balance sheet did not balance) One item that did not get reported on the initial 2003 1120S Schedule L was a revolving line of credit used predominately for payroll (of other computer programmers) as well as "some" personal expenses with a balance due on 12/31/2013 of $110K.
The bank did not change the name on the revolving line of credit until 2005 at which time the outstanding balance had grown to $300K.
Additionally the tax practitioner filing the return did not report the revolving line of credit on Schedule L of the 1120S until 2009 (column d) when the LOC had grown to $475K.
The 1120S gets examined for 2009, 10 and 11 and the IRS is asserting among other things that the $475K on Schedule L Line 20 - Debt - is also debt relief to the shareholder subject to personal income tax liability of the shareholder.
To make matters worse the previous return preparer it appears used Line 7 of the Schedule L - Loans to shareholders - to get the balance sheet to balance from 2003 through 2011.
How does one report an IRC 351 Transaction via 1120S Schedule L when a Sub S assumes all assets and liabilities of a Sole Proprietorship?
Can the debt of the sole proprietor assumed by the Sub S be treated as the shareholder's debt basis in the Sub S? Any direction is appreciated.
The bank did not change the name on the revolving line of credit until 2005 at which time the outstanding balance had grown to $300K.
Additionally the tax practitioner filing the return did not report the revolving line of credit on Schedule L of the 1120S until 2009 (column d) when the LOC had grown to $475K.
The 1120S gets examined for 2009, 10 and 11 and the IRS is asserting among other things that the $475K on Schedule L Line 20 - Debt - is also debt relief to the shareholder subject to personal income tax liability of the shareholder.
To make matters worse the previous return preparer it appears used Line 7 of the Schedule L - Loans to shareholders - to get the balance sheet to balance from 2003 through 2011.
How does one report an IRC 351 Transaction via 1120S Schedule L when a Sub S assumes all assets and liabilities of a Sole Proprietorship?
Can the debt of the sole proprietor assumed by the Sub S be treated as the shareholder's debt basis in the Sub S? Any direction is appreciated.
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Tax Professional Answers
Bill Robinson, CPA
Even though the corporate organizer is the sole shareholder, the corporation is respected as a separate taxpayer. The trap here for the unwary is that an "S" Corporation is still subject to many of the basic "C" corporation statutes except that the income & loss ( to the extent of basis ) flows to the shareholders. The controlling statute is IRC 357 - you may want to look at this. If the shareholder used the basis of the LOC for losses then you do have an additional issue if you try to remove the LOC from the argument. Alternatively you could argue that the shareholder was contributing capital to the corporation via personal draw downs on the LOC which remained in his name until 2005 and even though the bank changed it to the company I bet he was still liable via personal guarantee. Bottom line, this is very touchy in an IRS audit where the majority of auditors are not well-informed about corporate formation let alone S Corp issues. I would engage a competent professional that has experience with both tax controversy and corporate taxation. If taxpayer has not closed the audit there is still hope.
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