After the sale of all assets in an S-Corp liquidation, the only thing remaining on the balance sheet is a balance in long-term note payable to shareholder. Interest was paid to the shareholder regularly.
1) Is the note balance treated as a negative distribution to Retained Earnings to close the books? What is the treatment on the 1020S tax return? 2) Is this reported on the K-1? If so, where?Thank you for your help!
How many shareholders in the S-Corp?
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Just 2 shareholders. My wife and I.
Assuming you and your wife get along, I would make a journal entry on the books to reclassify the shareholder note Contributed Capital. No reporting is required on the K-1.
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This is why I so HATE loans to stocholders for pass through entities. It is much simpler and easier to run the money through contributed capital, add it to basis and treat payments as distributions. Its also almost always cheaper for taxes too.
The problem I have with Haskel's response is that we may be reclassifying AFTER-THE-FACT to get a better tax treatment than we're entitled to. While I would LIKE to follow Haskel's plan - and with some forethought I would have structrued it this was from the beginning - with the taxpayer setting up the way he did, this reclassification could result in a Section 1244 treatment for any remaining basis that is lost and this may not be appropriate under the circumstances.
In caes like this we have to look not only to the note but to the REASON for the loan to begin with - why did the stockholder loan the company money? Did they fall on hard times or was the corporation too thinly capitalized to begin with? The answers to these questions - and a few more - will determine the correct treatment of the liquidation.
My recommendation is that you get professional help with a local tax pro and SOON. I also assume that since the business return was due on March 17 that you've filed the appropriate extensions with both Federal and state agencies.
Good luck, Gene E. Utterback, EA, RFC, ABA
Can I still reclassify this note as contributed capital even though we have been taking interest income? If so, what date should the journal entry be made?
Any date after the last interest payment date. You can get fancy and you and your wife can actually make a capital contribution and take the money back as repayment of the note, but the effect is the same as a journal entry.
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