Q: S-Corp Tax question: On form 1120-S Schedule B line 12, regarding non shareholder debt cancellation, who's debt is it?

A: Line 12 on Schedule B of Form 1120-S is referring to a debt that the S corporation owed to a non-shareholder, and that debt was either canceled, forgiven, or had its terms modified to reduce the principal amount.

Here's a more detailed explanation:

1. The debt in question is a debt that the S corporation owed to a non-shareholder (i.e., a third party).

2. If this debt was canceled, forgiven, or had its terms modified to reduce the principal amount, the S corporation should answer "Yes" to the question on line 12.

3. The forgiveness of this debt by the non-shareholder may result in cancellation of debt (COD) income for the S corporation, which would then be passed through to the shareholders based on their ownership percentages.

Regarding your second question, if the shareholders of the S corporation forgave a debt as a gift to a non-shareholder, it would not be reported on Form 1120-S. Instead:

1. Each shareholder would need to file a Form 709 (gift tax return) if the gift exceeded the annual gift tax exclusion amount ($18,000 for 2024).

2. The forgiveness of the debt would be treated as a distribution from the S corporation to the shareholders, followed by a gift from the shareholders to the non-shareholder.

3. The distribution to the shareholders would be reported on their respective Schedule K-1s (Form 1120-S) based on their ownership percentages.

It's important to consult with a tax professional for specific guidance on your situation, as the tax treatment of debt forgiveness can be complex and may vary depending on the circumstances.