Discussion:Avoid Tax Trap Repaying Shareholder Loan?

From TaxAlmanac, A Free Online Resource for Tax Professionals
Note: You are using this website at your own risk, subject to our Disclaimer and Website Use and Contribution Terms.

From TaxAlmanac

Jump to: navigation, search

Discussion Forum Index --> Tax Questions --> Avoid Tax Trap Repaying Shareholder Loan?

SpicoliCPA (talk|edits) said:

12 September 2008
Greetings-I have a messy client (Welcome to the club!)

I read in the following article published by the AICPA that S Corp Sharehholders with 0 stock basis and 0 loan basis (Face value of loan $150,000) Treasury regulations section 1.1367-2(c)(1) provides for a “net increase” of the adjustment items rather than following the ordering rules required when adjusting stock basis.

Mr. Howell CPA states that if the corporation has earnings and distributions up to the amount of earnings during the year there is no net increase in adjustment items. Thus, the earnings will increase stock basis rather than debt basis and the distribution will be tax-free.

Has anyone applied this interpetation of IRC 1.1367-2? Seems too good to be true?

JOA Nov2004 Howell

Rkrcpa1 (talk|edits) said:

12 September 2008
My understanding has always been that you can distribute current earnings tax free

Beangrinder (talk|edits) said:

12 September 2008
This is a tricky topic, and I am still learning. The one thing to watch out for is if the S corp takes out a loan or runs up credit cards and still has a loss - the shareholders have no basis and can not deduct the loss. In most other scenarios, everything works itself out. For example, shareholder puts money into corp as loan or capital contribution (increasing basis) and then takes a loss (decreasing basis). If the S Corp is profitable, the only worry is paying reasonable compensation. As far as drawing the money out of the S Corp, this is a nontaxable event whether it is loan repayment or distribution. The profits are taxed through the K1 whether cash hits the shareholder bank account or not.

Kevinh5 (talk|edits) said:

12 September 2008
it is smoke and mirrors/chicken and egg argument

normally a distribution with zero stock & loan basis would be taxable

because the distribution comes out of current earnings, there is no net increase in basis

therefore the distribution (itself) is tax free (as Rkrcpa1 points out)

but the profit in the company (as shown on K-1, as Beangrinder points out) is still taxed

JR1 or Riley2 will correct me if I'm oversimplifying

SpicoliCPA (talk|edits) said:

12 September 2008
Seems we are on the same page, understanding the the Sole Shareholders K-1 will have flow-through income to 1040 of S Corp profit, but the distributions up to current year S Corp Profit should not be exposed to Cap Gains, Sch D.

Kevinh5 (talk|edits) said:

12 September 2008
now the question I have is why doesn't he take a repayment of sh loan instead of distribution? the profit will increase basis in the loan. why leave a loan on the books?

Waynecpa (talk|edits) said:

12 September 2008
Eventually if it is repaid the loan will be taxed as capital gains. As Kevin says, why not now when the rates are lower than they most likely will be in 2010+?

SpicoliCPA (talk|edits) said:

13 September 2008
My rationale-please correct me if you feel otherwise, is that a $35k repayment of loan with such a reduced basis will result in a very large calcualtion of capital gains this year(Net Present Value Issue). Client expects good years between now and 2010.

I figured Shareholder would wait until his basis in loan is restored then repayment of loan is tax free.

Additionally, @ 7% interest per year the Corporation is paying shareholder $10k per year in interest, which reduces potential payroll tax expense.


ReadMyLips (talk|edits) said:

14 September 2008
I just took a couple of s corp classes and have looked through the information. The general Income and Loan repayment rule is for income to increase debt basis first and then stock basis. That seems pretty straight forward. When you add a distribution to the mix, it's a little more complicated but you can use a special ordering rule allocating distributions to stock basis first (so that it remains at -0-) and then to debt basis. My materials don't have a complete cite, but it looks like the Treasury regulations section 1.1367-2(c)(1) cited in the AICPA article referred to. Here is the example:
                       Stock	       Debt		
                $ Amt	Basis	Face	Basis	Gain

Balance 0 100 70 Income 40 27 13 Balance 27 100 83 Distribution (27) Balance 100 83

Hope this helps!

ReadMyLips (talk|edits) said:

14 September 2008
Oops, my little table didn't come out the way it previewed.

The point is you can allocate the income to stock basis up to the distribution amount and increase debt basis by the excess. If $40 income and $27 distribution, allocate $27 of the income to stock basis and $13 t debt basis.

Blrgcpa (talk|edits) said:

14 September 2008
I'm confused. Was the loan made by the shareholder or a 3rd party? How can you have a 0 lan basis with a value of $150,000?

Earning increase the AAA account.

The shareholder should have a reasonable p/r before any distribution is made.

Harry Boscoe (talk|edits) said:

14 September 2008
The basis of an S corp shareholder's interest in his S corporation is the total of his stock basis and his loan basis. When he deducts losses, his basis is reduced, stock basis first, and then loan basis. This is the easy part.

When [if...] the corporation turns around and starts to make money, it gets very very complicated. The OP in this thread started out right in the middle of where it gets really really complicated. I thought I knew pretty much everything about S corp shareholders' loans, and then I read this thread. I'm going back to read the regs now. During the football game. Now, *that's* dedication....

To join in on this discussion, you must first log in.
Personal tools