If a corporation has a signed interest bearing promissory note for a loan from Shareholder, but has not made any money, therefore has not made any principal or interest payments during the year, does the corporation have to deduct the interest (they are cash basis) and issue a 1099INT to the shareholder?

Corporation who obtain shareholder loans must pay interest to shareholders based on the Loan agreement. This is the IRS preferred approach to shareholder loans made to corporations. But, in a situation, where a corporation is unable to pay any interest on the shareholder loans due to lack of funds does present some problems. The IRS position is that the Corporation should accrue the interest on these loans and debit the books with interest expense and credit the shareholder loan outstanding amounts. Then the corporation should issue the shareholder a 1099-Int for interest paid to the shareholder.

Clearly, this appears to be a deviation from the cash basis treatment, but during the course of some IRS audits, my experience has been that these are some of the adjustments that the IRS has made for my cash basis corporate clients!

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