Adam owns 60% and Boris owns the other 40% of S Corp. Adam and Boris are your clients. You had assisted

Instructions:

You should explain in specific detail and show all your work where applicable. Be sure and discuss all options available to the perspective clients.

Case Study:

Adam owns 60% and Boris owns the other 40% of S Corp. Adam and Boris are your clients. You had assisted the two shareholders in setting up the S corp.

The S corp was funded with undeveloped land with the view to developing the land. The development, however, never occurred. The land is still the only asset of the Corp. The land is still undeveloped, nor is the land rented. Thus, for the current year, the Corp has no income and no deductions. As a result, Boris wants to cash out. But for the most part, Adam wants to stick it out. Based on this state of business affairs, your clients are considering a number of ways for Boris to cash out. Several approaches to achieve this objective have been suggested to Adam and Boris by some corporate folks in your law firm. You have now been called in to address the tax consequences of each of these approaches. Adam and Boris also want to know if they will have any taxes to pay under any of the approaches. For this purpose, you can assume that both Adam and Boris will be subject to a 15% tax rate unless otherwise noted.

The land has a current value of 200,000 and a basis of 90,000 to the S corp. Both Adam and Boris have zero basis in their respective S stock. {Note a zero basis in stock may not be realistic but for purposes of this exercise it will work to make it easier.} The S corp is on a calendar year, cash basis of accounting.

Based on the case study above, answer the following questions below in great detail:

1. Approach 1

Adam is ready to buy Boris out with an 80,000 cash payment. Gain on the stock sale is subject to the 15% tax rate (as noted above). Adam is now the sole shareholder in the S corp.

2. Approach 2

In the alternative, the S corp sells the land to a 3^rd party for 200,000 and then distributes 120,000 to Adam and 80,000 to Boris in exchange of all their stock. The S corp then ceases to exist. That is, both Adam and Boris cash out. Adam decides to give it up as well.

3. Approach 3

In the alternative, Adam and Boris agree that the S corp could redeem Boris out, using the 40% of the land as the means to do so. Boris will then look for a buyer of his 40% interest in the land as a way of getting the cash he wants. Adam will continue as a shareholder in the S corp and the S corp will now co-own the land with Boris. The shareholders are ready to do the deal on May 1 (1/3 through the corp’s calendar year).

4. Approach 4

What if the sole asset in the S corp is not land, but an unoccupied building, subject to the 25% capital gains rate on any gain? What are the tax consequences to Adam and Boris in approaches 1-3 above?

5. Compare the treatment of Boris with that of Adam. Anything else to think about?