Tax question for S Corporation

[PastaPrimavera]

What is the name of your state (only U.S. law)? California

Tax question
There are two 50% owners in an S Corporation. One owner sues the other in a derivative action on behalf of the S Corp. As settlement, one of the owners relinquishes his share in the S Corp. to the other resulting in one owner owning 100 of the S Corp. In addition, the relinquishing owner pays the S Corp $10,000 to settle the suit. How is this accounted for? Are there tax implications and/or reporting requirements for these 2 transactions?

Thank you!!!

 

[Taxing Matters]

What is the name of your state (only U.S. law)? California

Tax question
There are two 50% owners in an S Corporation. One owner sues the other in a derivative action on behalf of the S Corp. As settlement, one of the owners relinquishes his share in the S Corp. to the other resulting in one owner owning 100 of the S Corp. In addition, the relinquishing owner pays the S Corp $10,000 to settle the suit. How is this accounted for? Are there tax implications and/or reporting requirements for these 2 transactions?

Thank you!!!

I’d want to see the lawsuit complaint and the settlement at a minimum to determine the correct tax treatment. There is an inconsistency here in the the lawsuit was a derivitive lawsuit on behalf of the corporation, thus the corporation is the effective plaintiff and the one shareholder is the defendant. I would therefore have expected the settlement to result in the shares being surrendered to the corporation rather than being transferred to the other shareholder. And, yes, those two transactions are different even though in the end the non-defendant shareholder ends up as sole shareholder of the corporation. There are certainly tax implications here, and the shareholders involved will want to see a tax lawyer or other tax professional to sort that out.

 

[PastaPrimavera]

I’d want to see the lawsuit complaint and the settlement at a minimum to determine the correct tax treatment. There is an inconsistency here in the the lawsuit was a derivitive lawsuit on behalf of the corporation, thus the corporation is the effective plaintiff and the one shareholder is the defendant. I would therefore have expected the settlement to result in the shares being surrendered to the corporation rather than being transferred to the other shareholder. And, yes, those two transactions are different even though in the end the non-defendant shareholder ends up as sole shareholder of the corporation. There are certainly tax implications here, and the shareholders involved will want to see a tax lawyer or other tax professional to sort that out.

Thank you for your reply! I believe you stated this correctly (and I didn't) in that the defendant would surrender his shares to the corporation. There is no settlement at this point but I'm trying to understand the tax implications in order to come up with a settlement that is optimal from a tax perspective. Any advice you can give will be much appreciated!

 

[LdiJ]

Thank you for your reply! I believe you stated this correctly (and I didn't) in that the defendant would surrender his shares to the corporation. There is no settlement at this point but I'm trying to understand the tax implications in order to come up with a settlement that is optimal from a tax perspective. Any advice you can give will be much appreciated!

If he simply returns his shares to the S-corp to the S-corp there is no taxing event there. However, the 10k in cash that he returns to the S-corp may be taxable, depending on what it is compensation for.

 

[PastaPrimavera]

If he simply returns his shares to the S-corp to the S-corp there is no taxing event there. However, the 10k in cash that he returns to the S-corp may be taxable, depending on what it is compensation for.

If I understand this correctly, the 50% stock surrender has no tax consequences until the now 100% owner withdraws dividends. What about the additional $10,000 paid to the S Corp as settlement for the lawsuit? Would this not also be considered paid in capital without tax consequences until withdrawn? How would the person paying the $10,000 report this? How could this be structured for maximum benefit to both parties? Thanks!!

 

[LdiJ]

If I understand this correctly, the 50% stock surrender has no tax consequences until the now 100% owner withdraws dividends. What about the additional $10,000 paid to the S Corp as settlement for the lawsuit? Would this not also be considered paid in capital without tax consequences until withdrawn? How would the person paying the $10,000 report this? How could this be structured for maximum benefit to both parties? Thanks!!

You cannot ask us that question because we do not know the backstory. You have to ask that question of someone who is either privy to the backstory or to whom you can tell the backstory. It definitely cannot be considered to be paid in capital, because the person paying it will no longer be a shareholder. Go see an attorney who can help you structure any settlement.

 

[Taxing Matters]

If he simply returns his shares to the S-corp to the S-corp there is no taxing event there.

I disagree. The details matter, and we don’t have them. At the very least, the defendant shareholder giving up the shares may have a loss on those shares upon surrender of them.

However, the 10k in cash that he returns to the S-corp may be taxable, depending on what it is compensation for.

We’d need to know what the money paid was for. Even using the word “returns” may not be correct. That suggests giving back to the corporation money the corporation had given the defendant for some reason, and we do not know that this is return of anything.

To the OP: the tax consequences turn on the nature of the lawsuit. So what was the claim in the derivitive lawsuit — what is it that you allege the other shareholder did that damaged the corporation — and what damages were sought?

 

[LdiJ]

I disagree. The details matter, and we don’t have them. At the very least, the defendant shareholder giving up the shares may have a loss on those shares upon surrender of them.

True, I was not considering the defendant shareholder's tax position.

We’d need to know what the money paid was for. Even using the word “returns” may not be correct. That suggests giving back to the corporation money the corporation had given the defendant for some reason, and we do not know that this is return of anything.

Ok, I can concede that point as well.

To the OP: the tax consequences turn on the nature of the lawsuit. So what was the claim in the derivitive lawsuit — what is it that you allege the other shareholder did that damaged the corporation — and what damages were sought?

It would be helpful to know that information.

 

[PastaPrimavera]

True, I was not considering the defendant shareholder's tax position.



Ok, I can concede that point as well.



It would be helpful to know that information.

Thank you all for your input. The initial paid in capital when the S Corp was formed was $5,000 for each owner. The cause of action is breach of fiduciary duty. Any suggestions for how this should be reported (or structured) and the tax consequences will be much appreciated.

 

[LdiJ]

Thank you all for your input. The initial paid in capital when the S Corp was formed was $5,000 for each owner. The cause of action is breach of fiduciary duty. Any suggestions for how this should be reported (or structured) and the tax consequences will be much appreciated.

That is totally unhelpful. If you want REAL advice, you have to talk to someone where you can give the true backstory. Its ok if you do not want to give it here, but that means that you need to consult with a local attorney.

And by true story, I means that you have to describe in detail, what actually happened.

 

[PastaPrimavera]

Can anyone suggest a tax specialist who could help me with this situation in SF Bay area, or California? Or suggest some tax liturature I could read to get a better understanding on how this could be accounted for Thanks!

 

[LdiJ]

Can anyone suggest a tax specialist who could help me with this situation in SF Bay area, or California? Or suggest some tax liturature I could read to get a better understanding on how this could be accounted for Thanks!

Again, you need a consult with a tax professional. Look for offices that are open year round. We have no more information now about your situation than we did before, so we could hardly recommend any literature.