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Old 12-29-2013, 04:57 PM
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S-Corp Shareholder Loan Repayment Tax Liability

Hello,

I have a 20-year old S-Corp. For the first 10 years of its life, it conducted business but then it ceased operations when I went to work for another company and then took some time off. At the time it ceased operation, the company had a retained loss of about $7,500. I chose to keep the company alive, in anticipation that I would eventually come back to work for the company.

Well, after 10 years, I finally have done that, perhaps a little later than I thought. For those 10 years, the company has conducted no business but it has paid its annual minimal tax filings for which I have loaned the company money each year. The company ended up with about $12,500 recorded as a shareholder loan to the company (that's the $7,500 plus the approx $500 filing fees each year).

For these past 10 years, the company has given me a Schedule K-1 showing a $500 loss each year. Each year, I recorded that loss on my 1040 Schedule E section III.

This year, the company has made about $35,000 income. The company paid me $10,000 as a reasonable salary. The company also repaid me the $12,500 loan.

I have just prepared a tentative Schedule K-1 using TaxACT which is showing $25,000 as net income and a box 16-E $12,500 loan repayment.

When I now enter this onto my 1040 Schedule E section III, the $25,000 causes a large tax liability this year. There doesn't appear to be anywhere to enter the $12,500 loan repayment amount.

I had not expected to have to pay tax on the loan repayment amount since it was my own tax-paid money that I have been lending to the company. How should I be reflecting this (either on the K-1 and/or on my 1040 E or elsewhere) so that the $12,500 loan repayment isn't treated as income?

Many thanks.
Jay.



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Old 12-30-2013, 12:37 AM
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Quote:
Originally Posted by Jaiy View Post
#1;When I now enter this onto my 1040 Schedule E section III, the $25,000 causes a large tax liability this year. There doesn't appear to be anywhere to enter the $12,500 loan repayment amount.


#2;I had not expected to have to pay tax on the loan repayment amount since it was my own tax-paid money that I have been lending to the company. How should I be reflecting this (either on the K-1 and/or on my 1040 E or elsewhere) so that the $12,500 loan repayment isn't treated as income?

#1;wages of $10k (reported on your 1040 line #7 while your share of S corp profits is reported on line #17)reported on W2 decrease S corp profits reported on Sch K1 of 1120S and 1040.



#2;it is not uncommon for S corp shareholders to make cash advances to the corporation during years when the company’s operating results are unfavorable or cash is tight. In return shareholders get an increase in their basis that they can use to deduct additional flow-through losses on returns as loan basis. It’s also not unusual for the S corp to repay these advances when operating results are more favorable. Unfortunately, however, if the parties treat the advance as debt and the shareholder uses the debt basis to absorb flow-through losses, any loan repayment may subject the shareholder to capital gain, or worse, ordinary income;the basis rules for S corporations provide that shareholders must adjust their basis each year for the flow-through items of income, losses and deductions.you, as a shareholder run into problems when you have reduced your debt basis and the corporation repays any part of a shareholder loan. When the company repays a loan where the debt basis is less than the face value of the loan, you must take a portion of the repayment into income.for example, say, in 2001 , you, as a 100%shareholder , made a loan of $100 to an S Corp. During the year the corporation had net loss items of $60. you had zero stock basis at the beginning of 2001. You were able to deduct the $60 loss by reducing your debt basis by $60. Thus, at the beginning of 2002, you had a zero stock basis and a $40; $100-$60, debt basis. During 2002 the S Corp. had $20 in income items and decided to repay you $10. The amount of income you recognized from the repayment was $4 (($40/$100)($10)). yiour debt basis was reduced by the $60 from 2001 and restored by the $20 from 2002, leaving a debt basis of $60 ($40 less than face value) at the time of repayment. Whether you recognize ordinary or capital gain income depends on the nature of the loans in their hands. IRC provides that retirement of debt instruments are exchanges. Thus, if a loan is evidenced by a note, the income portion of the repayment is considered capital because the note is considered capital in the shareholder’s hands. If the loan is an “open account,” or a loan not evidenced by a note, the income portion of the repayment is ordinary income.
In the above example you recognizes $20 ordinary income from operations and either $4 of capital gain or ordinary income, depending on the nature of the debt. However, with careful planning CPAs /IRSEAs can help the shareholder avoid recognizing gain on repayment. Where the shareholder is a 100% owner, logically any advances should be capital contributions rather than debt. Substituting capital for debt completely eliminates any possibility of the distribution’s creating income, provided the distribution does not exceed stock basis. Distributions in excess of stock basis trigger capital gain recognition.
In the case of multiple shareholders, CPAs/IRSEAs should recommend ratable capital contributions rather than debt. In the event a shareholder has a note outstanding in which the debt basis has been used to absorb losses, the S corp may defer any repayments until the debt basis has been restored to face value through income items. I guess you can contact a CPA/an IRS EA in your local area for more help in detail.



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Old 12-30-2013, 11:10 AM
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Thanks, Wnhough, for your quick reply.

I found out about debt basis just yesterday when I read similar info on the IRS and other web pages. But, I don't understand how this debt basis stuff translates to what the company puts on the sch K-1 and what I put on my 1040 sch E or elsewhere. And the debt basis calculation is something I've not been doing each year that I obviously should have.

In my case, am I right in understanding from your reply that my debt basis each year is zero since each year's loan was exactly equal to the company's expenses? In each of the previous years (the 2002 initial $7,500 and the 2003-2012 additional $500 amounts) I have indeed reflected these as losses on my 1040 line 17 (which came from the sch E). But does this debt basis being zero mean that I should not have done this? In which case, do I need to go back and re-file all these? In which case, what should I have put on the sch E's (or elsewhere) to reflect that zero basis?

Now this year, the company having income in excess of the total loan, am I right in understanding that my debt basis is restored? And, what does that mean for my 1040? Your formula for recognizing income seems to say that I should be able to recognize $0 of the loan repayment as income: (($0)/($12500)($12500)) right? So, I think it's the same question: seems like this $12,500 amount needs to appear on the 1040 (sch E or elsewhere) so that it offsets the total $25,000 income that I have. So, where do I put it?

Finally, if, as your last point suggests, I'd have been better recording all these amounts as capital contributions rather than loans, how would I have done that on each year's sch K-1 and each year's 1040? If there's a "next time", it'd be good to know how to do this properly from the start.

Thanks.



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Old 12-30-2013, 01:06 PM
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Quote:
Originally Posted by Jaiy View Post

#1;In my case, am I right in understanding from your reply that my debt basis each year is zero since each year's loan was exactly equal to the company's expenses?



#2;In each of the previous years (the 2002 initial $7,500 and the 2003-2012 additional $500 amounts) I have indeed reflected these as losses on my 1040 line 17 (which came from the sch E). But does this debt basis being zero mean that I should not have done this? In which case, do I need to go back and re-file all these? In which case, what should I have put on the sch E's (or elsewhere) to reflect that zero basis?

#3;Now this year, the company having income in excess of the total loan, am I right in understanding that my debt basis is restored?


#4;And, what does that mean for my 1040? Your formula for recognizing income seems to say that I should be able to recognize $0 of the loan repayment as income: (($0)/($12500)($12500)) right? So, I think it's the same question: seems like this $12,500 amount needs to appear on the 1040 (sch E or elsewhere) so that it offsets the total $25,000 income that I have. So, where do I put it?



#5;Finally, if, as your last point suggests, I'd have been better recording all these amounts as capital contributions rather than loans, how would I have done that on each year's sch K-1 and each year's 1040? If there's a "next time", it'd be good to know how to do this properly from the start.
#1;not each year’s loan was exactly equal to the biz’s expenses but the biz loss deduction as long as the biz’s stock basis is $0.i mean the bal in your AAA/stock basis is $0. What I mean is that it depends if you had stock basis/bal in your AAA acct. /loss deduction at that time;your debt basis is reduced by loss ( when expenses >S corp revenue and $0 in your AAA acct and stock basis)deduction. Assume that you, as a 100%shareholder , made a loan of $10k to an S Corp. so, during the year the corporation had net loss items of $10k. and you had zero stock basis at the beginning of the year.then, You were able to deduct the $10k loss by reducing your debt basis by $10k.then your debt basis is $0. Also assume that During 2002 the S Corp. had $4k in income items and decided to repay you $2k. The amount of income you recognized from the repayment was $2k>$0 debt basis; repayment of these loans is a taxable event to you the extent a full repayment exceeds your basis in the debt, or to the extent partial repayments exceed a prorated portion of the debt basis.
Stock and debt basis cannot be reduced below zero. The use of a Stock and Debt Worksheet, such as the one provided in the Small Business Quickfinder Handbook can greatly aid the process of calculating basis.




#2;it depends also;as you know, you making loans to the S-Corp may take a tax deduction in the current year for losses in excess of your stock basis, if losses exceed stock basis/AAA bal but only to the extent you have loan basis.your loan basis is reduced, but not below zero. So any excess neg. basis ( I guess you didn’t have it)is treated as a non-deductible loss. This excess loss is a suspended loss and carries over to future years indefinitely. The suspended loss may be deducted in any future tax year during which you havew restored your loan basis or stock basis. If you had both an equity investment and advanced a loan to the company, then in following years you must restore your loan basis before restoring your stock basis.you may restore your stock basis or loan basis in several ways. The easiest way to restore basis is to make additional cash investments to restore stock basis or to advance additional cash loans to restore loan basis. Adjusted basis cannot be below zero. However, adjusted basis will often result in a negative number due to transaction situations.


#3;the fact that having income in excess of the total exp. means you have positive bal in your AAA acct./stock basis.in this case, your stock basis/AAA acct bal are increased unless the net income is allocated to debt restoration .you need to advance additional cash loans to restore loan basis.; it is your responsibility to track your stock and debt basis. you need to calculate basis each year in order to prepare your personal tax returns. Why is this important? If you are allocated an S corp loss or deduction flow-through,you must first have adequate stock and debt basis to claim that loss or deduction.

You ,unless you have stock basis ,may be able to deduct losses as you have debt basis. Debt basis is obtained by loaning money to the corp. Guaranteeing a loan of the corporation does not provide debt basis; the loan must be owed directly to you. Once you, as a shareholder ,use debt basis to deduct a loss, it becomes a reduced basis debt. Debt-basis worksheets should be maintained in addition to the stock-basis worksheets. Items of income can restore the debt basis in subsequent years.you should be aware that you may have taxable income when the corporation makes payments on a reduced-basis loan as said previously. If you receive a payment on a debt before the debt’s basis has been fully restored, you need to recognizes taxable income for a portion of the amount of this debt repayment, based on the ratio of the amount of the basis reduction to the amount of the face value of the debt. As an example, a you loaned $50k to the S corp. In order to deduct a $20k loss for which you had no stock basis,you reducedyour debt basis by the $20k leaving a $30k debt basis. Subsequently $10kof the $50k loan was repaid by the corporation. Four thousand dollars of this repayment is taxable to you representing $20k reduction in basis as a percentage of the $50k face value of the loan times the repayment.




#4;correct;repayment of these loans is a taxable event to the shareholder to the extent a full repayment exceeds the shareholder’s basis in the debt, or to the extent partial repayments exceed a prorated portion of the debt basis. It is unusual for the corp to repay advance loans as operating results are more favorable. Unfortunately, however, if the parties treat the advance as debt and you use the debt basis to absorb flow-through losses, any loan repayment may subject you to capital gain, or worse, ordinary income.

#5;it depends on your loan situation; whether you recognize ordinary or capital gain income depends on the nature of the loans in yourhands. IRC section 1271(a)(1) provides that retirement of debt instruments are exchanges. Thus, if a loan is evidenced by a note, the income portion of the repayment is considered capital because the note is considered capital in your hands. If the loan is an open account, or a loan not evidenced by a note, the income portion of the repayment is ordinary income. As said, with careful planning CPAs /IRSEAs can help you avoid recognizing gain on repayment. Where you are a 100% owner, logically any advances should be capital contributions rather than debt. Substituting capital for debt completely eliminates any possibility of the distribution’s creating income, provided the distribution does not exceed stock basis. Distributions in excess of stock basis trigger capital gain recognition. In the event you have a note outstanding in which the debt basis has been used to absorb losses, the S corp may defer any repayments until the debt basis has been restored to face value through income items. I guess you can contact a CPA/an IRS EA in your local area for more help in detail.



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