Discussion:SHAREHOLDER LOANS TO S CORP
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BARBOLEARY (talk|edits) said: | 12 March 2007 |
| I have a new S Corp client. He told me that he is planning on making period loans to the company on an as-needed basis. He will receive annual interest based on the balance and get repaid as the company sees fit (meaning $500 here or $400 there, when it can afford it). Can he do this?
I was under the impression that a personal loan to a S Corp should be for a specified amount of money. Can he make intermittent loans as he said? Is this legal? How would you handle this? | |
| March 12, 2007 | |
| Sure, no problem. At year end, document the loan balance, issue a 1099INT for the interest paid to him. No worries. | |
| 13 March 2007 | |
| Yup -- sounds about right to me JR1 (of course that is the way I do it as well...) | |
| 13 March 2007 | |
| Barb-this is fine. I have an 1120S client that takes draws all year, he pays the same 941 amount each month, we file payroll taxes every quarter , then at the end of the year, I get his books and find he took more draws then he should have. We take it against his loan and issue him 1099 int. | |
| 13 March 2007 | |
| Is it better to have a shareholder loan? I booked my investment into my S corp as a capital contribution. It seems that it may be better to have the investment booked as a loan to the corp, with the corp paying me interest. | |
Gmacdon167 (talk|edits) said: | 13 March 2007 |
| Interest is not paid on "capital contributions" as they are just that, "capital contributions." Repayments are a return of capital and reduce stock basis, while contributions increase stock basis. Loans are loans, increasing basis only to the extent that they are needed to take losses. At that point, repayments are capital gain items as a percentage of stock basis vs loan basis.
Clear as mud, I know, but I had a few of those beverages you were talking about earlier. | |
| 13 March 2007 | |
| I just ask because some of my s-corp clients have a shareholder loan and some use the capital contributions. I'm still new at this and learning......more wine please? | |
Taxstudent07 (talk|edits) said: | 27 June 2007 |
| Good question - is it fairly common in practice to use loans for cash contributions after the initial formation of the corp? I'm aware that "distributions" must be based on ownership % and that return of capital (APIC) is based on the ordering rules, but the loans seem like a convenient method for returning cash to one SH without having to worry about maintaining ownership % of the group like in an actual distribution. | |
| 27 June 2007 | |
| It is quite common, especially for family owned businesses. Consider tax prep - lots of income Feb through April, but not much Nov and Dec. Quite common to have to "feed the alligator" with cash right before tax season to train employees, buy supplies and software, etc. | |
Taxstudent07 (talk|edits) said: | 27 June 2007 |
| Kevinh5,
Thanks - if an S-corp had three SHs, 70-20-10, and each pumped their % of 100k into the corp, would you classify this as SH loans or capital contribution? If the intention isn't to pull the $$ back out soon, would it be more "appropriate" to classify it as APIC? I guess what I'm seeing is that loans are preferable over capital contribs most of the time, especially if the corp will have the ability to pay interest on the balances at YE. | |
| June 27, 2007 | |
| The interest offsets on the 1040, so that doesn't matter, but yes, like you suggest, I prefer loans after the initial capitalization, primarily for the purpose of not worrying about disproportionate distributions. Ever. You distribute the profits once at the end of each year, to the notes. Whatever gets paid off the notes can never affect the S status. | |
Taxstudent07 (talk|edits) said: | 27 June 2007 |
| JR1 - your response makes sense. Also, please forgive me, but I'm not quite sure I follow when you mention distributing the profits to the notes - sorry for the ignorance.
Taxstudent07 | |
| June 28, 2007 | |
| Merely a journal entry after year end. Suppose profit is 20k, and would normally be transferred from current earnings to AAA. Instead, transfer it to a Note Payable-Shareholder, effectively distributing it already. Now the corp owes the S/H the money in the form of debt rather than undistributed profits. | |
Taxstudent07 (talk|edits) said: | 28 June 2007 |
| Thanks, JR1. | |
| 28 June 2007 | |
| JR, you have mentioned this before and I asked what you meant, but did not understand it until this response. I too tend to use SH loan vs cap contrib after the initial capitalization, if for no other reason except additional money out of corp to SH. I think one other thing to keep in mind, however, when you have more than one shareholder and one SH loans to the corp and the other(s) does not, then the interest does not offset. That is, 50/50 SHs, one loans to the corp and gets interest (100% to income on personal return), but only 50% deduction through K-1. Better to go to capital? | |
| June 28, 2007 | |
| Good point, Lynn. I guess I've never thought about that, but I do have s/h's where the notes are significantly different over time for one reason or another. One will get the benefit of a deduction and the other will pick up more income. Hmmm. Is there some rule we should know about to address that? I would never, let me be more clear, will never keep it in AAA for multishareholders. The fact is that distributions will be disproportionate at some point, and you've blown the S status. Unless you control the amounts that distribute into notes, keep the notes smaller, etc. But somewhere, somebody's going to screw it up and now you've got really big problems. I'd rather they be unhappy about the interest differential than deal with a non-S status... | |
JohnWalden (talk|edits) said: | 12 February 2008 |
| Hi JR1,
I've been reading quite a few discussions about S-corp distributions, and I read a lot of your comments about distributing the profits at year-end to "Notes Payable to Shareholder" instead of having undistributed profits. I understand that I would want to do this so that the distributions don't appear unequal someday. Could you please explain the entries for this? Does this money get recorded as a distribution and put on line 7 of the M-2 and also show up on the K-1s? Does the S-corp have to pay interest on these notes?
If anyone else wants to jump in to explain this, too, I'd appreciate it. Thanks! | |
| 23 February 2008 | |
| Hi - In looking at these interest discussions I have 2 questions. First, in another discussion JR1 discussed self charged interest. The Corp issues a K-1 with the interest expense and the SH reports interest income on Schedule B to offset. I think I missed something. This appears to be a wash with no true tax deduction. If the SH has actually paid this interest to a financial institution can they also deduct it as investment interest expense on schedule A for the deduction. Second, how would I report this. I have a client that formed an S Corp in 2007. He personally borrowed money and loaned it to the S Corp to buy a campground (hasn't be operational in 20 years). Other than incurring a few utility bills nothing was done with the business. How should this interest be reported for 2007? Thanks | |
| February 24, 2008 | |
| When the Corp borrows money from a bank or outside party, of course, there's a deduction. As I recall, if the SH borrowed it, it's not investment interest since he's involved in the company. Regular biz interest...Sch. E? But when the SH loans it to the corp, and rules say that interest must be paid, it's an expense to the corp, but income to him. Yes, it zeroes. That's ok. It's also money he can get out of the corp free of payroll tax and comp issues... | |
| 6 June 2010 | |
| Realize this is an old post but the last response comes closest to my situation.I have a new S corp client who is a single shareholder and has loaned the S -Corp money over several years to the tune of around $350,000 in principal . The S-corp is on a CASH BASIS. He has the loans documented with appropriate interest rate. The S Corp has made no interest payments for several years but has been accruing and reporting it on the balance sheet for their internal purposes. They indicate when the business turns around and they have the ability to repay the accrued interest they will. There has been no tax deduction for the interest on the S-Corp tax return (Cash basis taxpayer ) and no phantom interest reporded on the personal return. Does this seem correct or should I start issuing a 1099 INT and report the interest on the personal return? Thanks for your help | |
| June 7, 2010 | |
| You're fine. As long as both returns report the same thing, you're ok. | |
| June 7, 2010 | |
| Income and deduction will typically match, but they might not, and if they don't, it can't be in your favor. I would prefer to treat the unpaid interest as a contribution to capital. | |
| 7 June 2010 | |
| I have some problems with the indiscriminate use of the shareholder's loans accounts, especially when tax avoidance is the motivation. IRS is claiming to target S corps and, in particular, S corp loans. They are looking for entries in corporate minutes authorizing loans, actual promissory notes evidencing these loans, business purpose, etc. IRS can reclassify these loans as capital or distribution which could possible result in involuntary termination of election. Another common example is when distributions are in excess of the AAA account, the preparer simply reclassifies the distribution as loan to s/h, rather than risk capital gains to the s/h. This constitutes a preparer making an unauthorized management decision which according to an ethics course I recently took, subjects the preparer to major liability and is a big no-no. | |
Jeffreymcclellan (talk|edits) said: | 3 November 2010 |
| I have a similar issue. I have a client who is a 50% S-Corp shareholder (her husband is the other 50%). She used personal credit cards to advance cash to the S-Corp as well as charging business expenses. She has other personal items on these cards as well. I think there have been inconsistencies with the credit card payments. The company appears to pay some and she has paid from her personal bank account too. I am currently going through the books to map all of these out but am torn on how to treat these and why. She would like to see these as all capital contributions and not a loan. Anyone have thoughts as to why I would choose capital and not loan? | |
CathysTaxes (talk|edits) said: | 3 November 2010 |
| Jeffrey, since your client is a S-Corp, she needs to document these types of transactions and how the S-Corp is to treat them.
She can make these additional paid in capital, loans from shareholder, or set up shareholder's expenses. If she chooses the APIC, then it is my understanding that this money stays in the scorp and she can't take a distribution from this account. If she makes it a loan from shareholder, then when the scorp is out of its cash crunch, she can repay the loan plus interest to herself. If she sets it up as shareholder expenses, after she debits the expense account she can credit a notes payable to herself. | |
| 5 November 2011 | |
| Hi,
Could someone help clear up a few things for me? I have a cash basis S corp owned by one cash basis Shareholder. Shareholder loaned S corp $1M at 8% interest rate, which is above AFR rates. Let's assume that we do not have a below market loan issue if interest has been paid rather than accrued and unpaid. Although S corp has not made any loan payments or interest payments, it has been accruing interest and deducting the interest expense every year. Additionally, S corp has increased the loan balance by the amount of the unpaid interest each year. Shareholder had been including the interest income in his gross income each year. If both are cash basis taxpayers, is it permissible to deduct the unpaid interest and include it in gross income? Do we have a below market loan problem if the interest was accrued but never paid? Is it considered paid if the interest was added to the loan balance each year? If the unpaid interest continues to be accrued and added to the loan balance, is there a risk for 2nd class of stock treatment? Since interest has not been paid, I do not see why this should have been a loan in the first place... Shouldn't it have been treated as an additional capital contribution? There seems to be too much work for no actual payment of interest. I would like to recommend to the client that the loan be treated as paid and have it be treated as a capital contribution. I would appreciate your help and input. Please provide authorities with your answers as well. Thank you in advance for your time. | |
Spell Czech (talk|edits) said: | 5 November 2011 |
| taxlawgal: You'll get fewer crabby and grumpy responses to your post about S corp shareholder loans if you'll fill in your professional profile on your user page. | |
| 5 November 2011 | |
| Crabby and Grumpy here...an S-corp owned 100% by one guy. Why a loan in the first place? | |
| November 5, 2011 | |
| I have no problem with it. Presumably he'll want to one day repay it, and when it's capital, as I understand it, that's difficult to do. (I've been told you're not allowed to touch the capital unless there's a sale of stock.) The procedures have been followed correctly in my opinion. Yeah, it's some work, but back in the day, it was a big deal, and IRS was quick to reclassify it as capital, which was sometimes devastating to the S status. Not so much anymore, esp. with only the one shareholder. | |
RoyDaleOne (talk|edits) said: | 5 November 2011 |
| "I've been told you're not allowed to touch the capital unless there's a sale of stock."
FYI this not always true. State law covers what you can do and the results of what you did. Additional paid in capital in excess par value represents what? | |
| 5 November 2011 | |
| The problem with a loan is that they're usually made to businesses that are losing money. Then, losses pass-thru and reduce debt basis. Then, a partial repayment is made, which triggers gain on a reduced basis debt. This doesn't happen with equity. | |
| 6 November 2011 | |
| "Anyone have thoughts as to why I would choose capital and not loan? " Perhaps there are bank loan covenants or perhaps there are capital requirements for bonding that make capital a better choice. | |
| 6 November 2011 | |
| Can I add a point or question? The accrual of interest income to the s/h on their 1040 is required as done due to the related party nature. But isn't the deduction by the corp still limited to when paid? | |
| 8 November 2011 | |
| Hi again,
I will fill out my profile shortly. Sorry but I did not know that was required. Thank you very much for your responses. I really do not understand why the prior accountant set up the loan rather than just treat it as a capital contribution if the goal is to have basis to absorb losses. Do you see why a loan would be a better option? Why would it be a bad thing to touch capital prior to the sale of stock? I do not see why the $1M could not be treated as a capital contribution in the first place. As to the need to accrue interest expense by S Corp even though the S Corp has not and will not be making any interest payments, it is required because we are dealing with related parties transaction??? Are you saying that I should not recommend to the Client to treat the current loan as paid and have the amount as a contribution to capital? I just do not see why the Client should continue to do the dance of accruing interest and expensing interest by S Corp and including matching amount as interest income in Shareholder's gross income. I see that I will have to worry about potential capital gain treatment of any debt repayment since Shareholder has been using the debt basis to absorb losses over the years. Just making sure I understand your responses. Thank you again. | |
| 8 November 2011 | |
| Hi again,
I will fill out my profile shortly. Sorry but I did not know that was required. Thank you very much for your responses. I really do not understand why the prior accountant set up the loan rather than just treat it as a capital contribution if the goal is to have basis to absorb losses. Do you see why a loan would be a better option? Why would it be a bad thing to touch capital prior to the sale of stock? I do not see why the $1M could not be treated as a capital contribution in the first place. As to the need to accrue interest expense by S Corp even though the S Corp has not and will not be making any interest payments, it is required because we are dealing with related parties transaction??? Are you saying that I should not recommend to the Client to treat the current loan as paid and have the amount as a contribution to capital? I just do not see why the Client should continue to do the dance of accruing interest and expensing interest by S Corp and including matching amount as interest income in Shareholder's gross income. I see that I will have to worry about potential capital gain treatment of any debt repayment since Shareholder has been using the debt basis to absorb losses over the years. Just making sure I understand your responses. Thank you again. | |
| 8 November 2011 | |
| One issue you run into is if another shareholder is brought in. In that case, original shareholder will obviously want to be repaid the $1m with the new s/h getting $0 of the $1m. | |
