Steps to Buy Out a Partner in a 50/50 S Corp
S corporations are often small companies with a limited number of closely related partners. When one partner decides to leave, he can sell his interest to the remaining partners. Negotiations may become difficult when the S corporation is split evenly between two people. You may need to call in a third-party appraiser to determine the company's value if you cannot agree on a buyout amount on your own.
Start by looking at the S corporation agreement you signed when starting the company. The corporation agreement may have a buy-sell agreement already incorporated into it. The buy-sell agreement will explain the process for initiating a buyout, valuing the partner's interest and setting payment terms. One partner cannot force the other to accept a buyout unless this right is specifically stated in the buy-sell agreement. This can be a problem for shareholders wanting out if the agreement also prohibits the sale of stock to third parties.
Partners in an S corporation may loan money or equipment to the company from time to time. You must calculate the partner's debt basis before the buyout offer because it reduces his overall equity in the company. A partner may also be allowed to make an indirect loan through inter-company transfers among commonly controlled companies. Reduce the amount of the debt by any loan payments made or debts forgiven.
Prepare a stock purchase agreement to formalize the buyout. List the details of the sale, payment terms and the date the stock will be transferred. Once the transfer of shares is completed, record the information in the company's stock ledger. The seller must also sign the transfer certification on the back of any paper stock certificates he holds.
Negotiate a payment schedule for the buyout if there is no buy-sell agreement on file. It may be hard for the company to handle paying the full amount in one lump-sum payment, so recurring payments over a specified time frame could be a better solution. You do not want to cripple the company's cash flow immediately after the buyout. You can add an earn-out clause that ties the payment amount to the company's income so that the seller gets paid faster when the corporation can afford it. These provisions help deter the exiting partner from competing with the company or harming its business prospects after leaving.
You can also use a redemption of stock to buy out the exiting partner. Redemptions offer a trade of corporate property in exchange for the partner's shares. If the property has appreciated in value since its purchase, the redemption will create a capital gain that must be reported and passed through to the remaining partner on Schedule K-1. The selling partner must pay capital gains tax on the difference between the redemption value and his basis in the stock.