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S Corporations
When consulting on S corporation asset sales or sales treated as asset sales from a tax perspective, such as a stock sale with a Sec. 338(h)(10) election, tax practitioners need to be aware that different tax consequences than expected can sometimes result under the installment sale rules of Sec. 453. The process is further complicated because, in many situations, a shareholder s outside basis in the S corporation stock is different from the inside basis of the S corporations assets.
Different results can occur under the installment sale rules depending on whether the S corporation liquidates or stays in existence. Advance planning for when the plan of liquidation is adopted can make a big difference in the tax results for S corporation shareholders. In addition, the use of a "one-day" note could assure parity in treatment on when gains are recognized. Lastly, the risk of capital losses in future years, which are limited to $3,000 per year in excess of capital gains, can be mitigated by advance planning.
Example 1: An S corporation has one shareholder with zero stock basis. The S corporation has zero tax basis in its assets and no liabilities. The S corporation sells its assets and receives a $1,000 note due in one year. The entire $1,000 gain is eligible for installment sale reporting under Sec. 453.
The realized gain on the asset sale is $1,000, but none of the gain is recognized. After the asset sale, the S corporation adopts a plan of liquidation and distributes the note in liquidation. The general rule of Sec. 453B(a) provides that if an installment obligation (an obligation of the purchaser a seller received in an installment sale to which the installment method applies) is satisfied at other than face value or is distributed, transmitted, sold, or otherwise disposed of, the seller recognizes gain or loss equal to the difference between the obligation's basis and the amount realized on the sale or exchange.
Under these rules, the note's distribution is treated as a disposition of the installment obligation. The S corporation recognizes gain of $1,000. The shareholder recognizes no gain or loss on the distribution, as the basis in the S corporation is increased to $1,000 by virtue of the...