If you were to loan me $20k today, would you insist on loan documents, regular payments, and interest? Of course you would! Such requirements and documentation would seem to be common sense, so why do many shareholders fail treat the loans to their S-Corporations the same way?
An S-Corporation is a separate legal entity, and any transactions between shareholder and the corporation have to be treated as such. Any funds contributed by the shareholder are either capital contributions or loans from the shareholder. If the corporation pays personal expenses for the convenience of the shareholder, the payment has to be reclassified as a loan from shareholder repayment or a distribution. There needs to be a very clear distinction between shareholder and corporation with these transactions and the documentation should be the same as if the transactions were with an unrelated third-party.
In my experience, I have seen this issue come up in IRS audits and with bank loan renewals and applications – especially with S-Corporations owned by a single shareholder. Without other shareholders to help keep things formal and a clear separation between business expenses and shareholder personal expenses, the single shareholder can get lazy and end up using their S-Corporation like a personal checking account. If matched with very poor documentation, this can lead to big problems with the IRS – even loss of the S-election status in serious cases.
How can you avoid these problems and make sure you are properly documenting your shareholder loans? Here are my suggestions based on my experiences with small S-Corporations:
- Keep your personal expenditures and transactions out of the S-Corporation. It is a separate legal entity and there is no reason for co-mingling personal and business transactions except for the occasional payment for the convenience of the shareholder.
- Reimburse any expenses paid personally on a regular basis via an signed expense report. Attach receipts and document the who, where, what, and why for meals and entertainment, travel, and other expenses that need explanation as to the business purpose.
- Avoid using personal credit cards for the business; however, if you must resort to this, try to use the card(s) exclusively for business and then use other personal credit cards for personal transactions.
- If you loan funds to the S-Corporation, keep a record of the loan and try to have the corporation make regularly scheduled repayments. If the loan exceeds $10k, the corporation needs to start tracking and paying interest on the loan principal.
- Talk with your CPA and make sure you understand any reclassification entries made to loans from shareholder accounts.
- Use a lawyer that specializes in small business that will prepare demand notes and documentation for the loan from shareholder on a regular basis. Many small S-Corporations try to cut corners in this area and it can really hurt them down the line.
- Document, document, document! I know life is busy and small businesses require more time than you have, but do not get behind on this or create excuses for yourself. If you cannot meet documentation requirements, then you should not be incorporated.
PDXCPA - Portland Small Businesses Tax Blog 
I read your article with much interest. I am a single shareholder of an S Corporation. I document everything. But I am curious about the loans. When I incorporated I brought in 193k of inventory, receivables, and cash to the Corporation. The CPA said that I just needed to create a liability account for this. Didn’t sound right to me but that’s what I did. A year later I went to another CPA and got the same information. Now, I logged that 193k in as a loan. The Corporation paid it all back and I (shareholder) loaned it back again. All the while documenting everything. The only thing is, in my loan papers I showed a 5% interest rate but when it came time to pay it, I just waived the interest.
What is the correct way to handle this and straighten it out on my books, if necessary?
Thank you.
Dave
Actually, on loans FROM shareholder, it is very common for CPAs waive the interest altogether. I have done it myself many times, but ultimately it depends on the circumstances. If I know a client has a very good lawyer, I will put interest on the loan because most lawyers are going to want interest on it when they put together the annual documentation for the client.
Technically, we should be putting interest on all shareholder loans over $10K like I suggest in this article. By doing this, I believe you are fully protecting yourself from it becoming an audit concern. It is true that the IRS often does not press the loan from shareholder interest issue; however, I always try to minimize the number of audit issues, and accruing interest on a shareholder loan is a fairly easy way to do this.
If it was a loan TO shareholder, we would have a different scenario. Interest should always be charged or accrued on loans to shareholders over $10k.
In your situation, I do not think you really need to make any corrections; however, there is one item of concern with regard to your initial contribution to the corporation. Technically, when you contributed non-cash items into the corporation (A/R and inventory), it should have been offset against “Additional Paid-In Capital” rather than the loan from shareholder. However, it is probably a moot point now as I am assuming it has been a few years since incorporation. It just means that your corporation is much more thinly capitalized then it should have been. It is not the end of the world, but it is a good thing you are no longer using that first CPA. 🙂
I hope that helps.
Hi,
I am in business with 3 others, s corp, we all own 25%. The corporation paid for a mortgage on a house that was initially going to be used to expand the business, however it became living quarters for our father. I took my name off the house several years ago( due to illegal activities) & asked that the house be pd for personally, not through the biz. This did not happen. The house was just sold & the other shareholders pocketed the cash. I thought it should be returned to the corp. At first our accountant said it needed to be returned to the corp, but then changed her mind. Is this legal? I am very concerned. Thanks, Mieka
It all depends on how the items were treated on the prior returns. If the corporation was making the mortgage payments and the tax preparer was posting them as distributions to the shareholder (personal transaction reclassification), then the funds would not need to go back to the corporation. Hopefully that is the case, otherwise your concerns are valid.
Did the corporation own and depreciate the house?
Hopefully this is not the case. Appreciating property should NEVER be put in a corporation – reason being that any transfer to a shareholder would create a taxable event since it has to be transferred at fair market value. Then if there is a gain on the property, you would have recaptured depreciation as well. Not a good scenario…
There is also the personal tax aspect. Hopefully someone was able to show that they owned and used the house as their primarily residence for two out of the last five years.
Sounds like quite a complex situation. If you were really concerned about it, you could meet with a CPA that is independent of the other shareholders; however, the CPA would need copies of the tax returns, financial statements, and any workpapers available in able to give you good answers.
You might also want to seriously think about selling your shares in the company. Multi-owner businesses are like marriages, and you business doesn’t sound like a healthy marriage.
Hello,
I am doing ap/ar for a lady who runs an S Corp.
She uses her BUSINESS credit card for personal use. I told her to stop doing this for one.
However, the old accountant that used to do this set up an account “Shareholder Loan” as a LTL for these personal uses to go to.
This doesnt seem right. The owner of the business isnt planning to pay these items back. The owner also does not take a salary.
1. What should these personal items be put to? What type of account? (this is done in QB).
Thanks,
Lisa
Personal expenditures are non-deductible and therefore should be classified as distributions (which is an equity account). However, it sounds like the shareholder had a loan from shareholder balance, so rather than classifying the personal transactions as distributions, the accountant was simply reclassifying the personal transactions as loan from shareholder repayments. Once this loan balance is fully repaid, then they would have to be distributions.
Whether a personal expenditure is a distribution or loan from shareholder repayment is a tax return presentation issue, so for QB – I would just use distributions for all personal transactions. The items do not necessarily need to be paid back.
The bigger issue is the salary. You might let the owner know that S-Corporation shareholder have to take a reasonable wage, and a zero wage is a big red flag to the IRS and an easy audit adjustment for them. She should check out my post on S-Corp reasonable wage.
Can personal credit cards used by an S-Corp shareholder for business expenses be treated as a loan from stockholder thus creating basis that will allow the stockholder to deduct losses? How do you recommend recording this type of activity?
Yes, but you have to careful with debt basis. It is important that the shareholder experience an actual economic outlay to acquire the basis (see Rev. Rul. 81-187). In english – the credit card should be solely in the shareholder’s name and the shareholder should be making the actual payments (not the corporation). This means when expenses paid with the credit card that they are booked as loans from the shareholder, and then the corporation repays the shareholder on the loan when the shareholder needs to make a credit card payment. Guarantees by the shareholder do not work – must be in shareholders name only.
Also, making yourself a co-maker on a corporate loan does not work either. You have to be very careful if you are trying to “restructure” loans to get basis as there are a lot of court cases in the IRS’s favor in this area.
I have used this before for a shareholder and it does work well that first year that the credit card balance is reclassified; however, usually it is with clients that have poor records and later told me the credit card was personal. Had they originally provided good records with actual credit card statements, I would have known that the credit card accounts were personal and I would have already used that basis against losses.
Hope that helps.
On my 2007 tax return, my accountant did not place loan to shareholder on the return…..In QB, it is recorded loan to shareholder and when I receive distributions from the company, it offset my loan to the company…..
In 2008, I moved and had another accountant who stated I needed to place loan to shareholder amount on the tax return?
Which is correct? And how is the distributions amounts figured out on the return?
It is likely that the loan to shareholder was reclassified as most accountants would not simply leave a balance off the return as Schedule L, M-1, and M-2 would not balance.
Here is how distributions work when you have a loan to shareholder…
Distributions can be taken from the current year earnings or from retained earnings, so your maximum limit each year is the net income and any remaining retained earnings from the prior year. When your distributions exceed these amounts, a loan to shareholder account results. The loan to shareholder can only be reduced by repayments by the shareholder or reclassifying them as distributions when the limits allow. Most CPAs and accountants try to clear the loan to shareholder balance to distributions whenever there is net income and “room” for the reclassification. It sounds like this what happen in your case. The way you check that is to compare distributions in QuickBooks to the distributions on the return. The difference is likely the balance you are looking for.
The other possibility is that it was offset against a loan from shareholder account. If it is actually error, then you have bigger problems and will likely need to amend depending on the circumstances.
One final note, it sounds like the bigger problem is that you are not getting adjusting entries from your accountants. The QuickBooks accoutants copy makes this very easy, so accountants should have no excuse. Make sure you get the journal entries so that your QuickBooks file matches the tax return, which will also let you see what they changed. If you don’t understand an adjustment, make sure you ask.
You wrote: “It is likely that the loan to shareholder was reclassified”. Let’s reverse that and say it was a shareholder loan to corporation. If on the 2007 return it was on the balance sheet as a “shareholder loan to” and on the 2008 return it was reclassified as something else like “Additional Capital Contribution” for example, would that loan need to be recorded as a loan paid back and show up as a distribution (on K1) or is just reclassifying good enough?
Thanks.
Dave
It is a little rare to reclassify a loan from shareholder (to the corporation) to additional paid-in capital since those funds become part of the permanent capital stock of the corporation; however, there might have been concern that the corporation was too thinly capitalized. I prefer not to do this as it can cause problems later if the shareholder(s) take too much in distributions.
The reclassification would be good enough as far as documentation goes. It would not show up on the K-1.
If you placed property into the S-corp as a shareholder loan to the S-corp, can you remove property from S-corp as repayment of that loan to shareholder? This shareholder owns 100%. And how do you value the property? Cost basis or current market value?
What if you never placed property into S-corp only cash? Can you still take property as repayment?
Actually, loans can only be cash. When you contribute property to a corporation it is valued at fair market value (or net book value if depreciated in a sole proprietorship or another entity) and becomes additional paid-in capital.
Any time you take property out of a corporation, it has to come out at fair market value, and it is effective “sold” to the shareholder.
This why you should never put appreciable property in a corporation.
opps!..typing error in e-mail address on 1st request.
Hello Brian,
I am 51% owner/operater/shareholder with partner 49%. We are structured S-corp for 9yrs. We have never had a year with profit. Some years where break even but depreciation gave net loss carryovers thru K-1. Through out the years documented shareholders loans where made to keep the corp running with the expectation we would reap benefit later….NOT. It’s time to get out !! So here is where we are today…Shareholder loans to corp amount to $300,000. Current Liabilities $70,000. Capital stock $10,000. Assests after depreciation $30,000. Equity ($270,000).
We have valued assests at $175,000 and corp seal, customers etc at $25,000 with no accounts recievable and have found a buyer for our failing s-corp.
How do we write off shareholder loan balance so new owner recieves business free and clear ?
It depends on how you sell the business. You will either sell the stock or sell the assets.
With assets, you question is easier to deal with as the S-Corporation would have a final return and the loan and liabilities would be dealt with in liquidation, and in the end you could have a gain or loss. It always depends on the circumstances, and the thing you have to realize is that the loans to the company over the years gave you basis to deduct the losses – so even though there are loans to the corp of $300k, you may not receive repayment or have basis equal to that amount.
If you sell stock and the buyer continues the S-Corporation, it gets a bit more complicated and the loan is essentially “liquidated” or “cleared” upon sale of the stock. In a sense, the new owner would receive the business “free and clear” in that their basis in the corporation is based on what they pay for it; however, you do inherit many aspects of the business by buying stock rather than assets, so I would strongly suggest both parties hire professionals as it is far too complicated to try and do yourself. Plus, the smallest oversight can be very costly, so get a lawyer and CPA and suggest the buyer do the same.
For my new S Corp., I would like to buy furniture for my office using a personal credit card instead of my S corp credit card. The S Corp. would own the furniture and would have a loan to shareholder. Could I than apply the loan against my distributions for the year? This is a new S corp. (6 months old) I have not been paying federal payroll taxes just yet because my income has been sporadic. I would like pay my payroll taxes before year in.
The purchase using the personal credit card would create a loan from shareholder to the corporation. Distributions taken during the year could be reclassified as loan repayments rather than distributions.
Alternatively, you could just have the corporation reimburse you for the purchase. It can be cleaner, but it only works if the cash flow is there.
It is crucial you pay yourself a reasonable wage before year-end. See my post on reasonable wages for S-Corporation shareholders. You do not want to file an 1120S with zero wages for the shareholder – especially if you have taken distributions during the year. You still have time and could even reclassify some of the distributions as net payroll.
Back to the issue on “restructing” personal credit cards as shareholder loans so you can use the debt basis to deduct loses, you mentioned some court cases resulting in favorable IRS decisions. If it’s not too much trouble could you lists a few recent court cases or tax rulings (I read through ReV Rul 81-187) where this taxpayer position was taken and IRS disallowed it.
I have a client wanting to take this avenue, but I haven’t been able to find a lot of information regarding this specific strategy.
Try these…
Miller v. Comm TC Memo 2006-125
Gleason v. Comm TC Memo 2006-191
I also have a client who read somewhere that you can covert personal credit cards used by the business to shareholder debt basis, I looked at the proper way to structure it (in a post above), it looks like in my situation that CC debt is sitting on the books as Accounts Payable to the CC vendor and the Company pays the bill directly to the CC company. If I simply reclassify the CC in accounts payable to shareholder loan as use it as debt basis, would that be a slam dunk disallowance by the IRS if it ever got audited???
Could be – it just depends on the amount and the auditor. Items like that can often be ignored if the amount is not material. However, you are right – if the auditor challenges it, you do not really have a strong case for classifying it as debt basis.
I am the 100% owner of a c-corp and am paid a salary. For several months in 2009, I skipped paychecks due to cash flow.
Can I show the missed salary as a loan from shareholder on the balance sheet?
Actually, that is a slightly different issue. You cannot show a loan unless funds were actually loaned to the company. Non-payment of wages does not create a loan from the shareholder. You would have to pay the wages first and then loan the net pay right back to have actual loan from the shareholder.
If anything, you just have deferred wages that can be paid when cash flow improves.
Brian,
I own 35% of an S-Corp. I and another 35% owner have been working it. There are 3 other 10% owners that are not involved in the actual running of the company and hold no office or position with the company.
After reading your posts I realize that the two owners that actually work the business have not been taking the required reasonable salary for 2008 and 2009. In 2008 there were repayments made by the company of shareholder loans- but since they were repayments of our own money we did not pay/deduct any payroll taxes.-we did exactly what you said not to do we filed an 1120S with zero salaries for the owners.
how much trouble are we in?
Well, it is definitely not ideal, and I do not know how much the IRS audits solely based on zero shareholder wages, but I tend to look at two other items in this type of situation – net income (loss) and shareholder distributions.
If there is material net income and distributions to the shareholders, then your risk of “trouble” with the IRS is much greater.
If there is a net loss or immaterial net income and no distributions, then I think you have an argument that wages could not be paid, and as long as you document that fact and pay wages later when profitable, then I think you have little to worry about.
Whether there were distributions or not is important as the IRS could argue that some or all of the distributions payments should have been paid as wages.
As far as repayments of loans go – just make sure the loans are documented correctly. The IRS would have a hard time arguing the repayments should have been wages if the loan is properly documented.
My S corp client has a loan from shareholder payable. During 2009, the bookkeeper started accruing interest at 4% annual rate on a monthly basis. In past years we have not accrued any interest. Should we go back an accrual interest for prior years on 12/31/09? If so, how do you suggest we do this?
No, I would not worry about it other than to maybe document the fact that the interest was waived or deferred in the past. I do not think it would really raise an issue in an audit situation.
If it was a C Corp and and a loan TO shareholder over $10K, then you would have an issue.
Brian,
We have dissolved our S-Corp and, after paying all other bills and selling all assets, have $50,000 of partner loans and acrued interest to the S-Corp to write off. Does the notes written off get reclassified to shareholder basis (and then the partners show it as a capital loss?) or do the partners get a deduction on their personal return for bad business debts. Does the S-Corp have to file any govt informaitonal forms on the debt written off?
Thanks for your help.
This can be a confusing issue because there are two distinct balances with regard to the loan from shareholder:
1) Book balance – this is the $50k liability balance on the books. It only represents the amount loaned to the company less repayments and is not what can be deducted as a loss.
2) Debt basis balance of the loan – this would be the actual remaining basis from the loan. This balance would have been tracked from the origination of the loan, increased by additional loans and accrued interest, and reduced by repayments and tax deductions/losses applied against the basis.
In most liquidations where the shareholder has had net losses in prior years, there is often no remaining debt basis from the loan. For example, a shareholder loans money to the corporation because of cash flow issues and by doing so is able to deduct losses that would have otherwise been suspended. Over the years, if the losses deducted reach the balance of the loan, then there would be no remaining basis and no loss on liquidation since the shareholder has already received the tax benefit.
Make sure you get the basis statement with the K-1 from the CPA/tax preparer and you might review the basis statements for each year from the inception of the loan. Sometimes basis statements are incorrect and not updated correctly, so a in depth review at liquidation is definitely recommended. If no remaining basis, then there is no loss upon liquidation.
Hi Brian–
I am in a similar situation. We are liquidating our company, BUT both shareholder and non-shareholder loans are being forgiven, as the company has no money to pay anyone back. Can I use my “bad loan” to the company to offset Cancellation of Debt Income from forgiving the non-shareholder loan? If so, where does it all get reported? We can no longer afford to pay an accountant.
I believe the non-shareholder loan goes on 1120S SCH B-11 and the tax software sends it through the return to each K-1, but I am not sure where to enter the bad shareholder loan amounts. Also, we did pay one smaller non-shareholder loan back–is that considered COGS, or is it reported somewhere else?
Thanks!
Dear Brian,
I read your the article “Loans from S-Corporation Shareholders” and the various responses with great interest. The last bullet point of the article clearly states Document, document, document! I am part of a newly formed S-Corp with a Loan from S-Corp Shareholder. Regarding documentation is there a requirement to supply the shareholder with any type of year end tax reporting statement beyond a K-1 that reflects interest paid to the Shareholder?
Thank you for your help
There is nothing required beyond the K-1 package (K-1, basis stmt, attachments, etc). Required is the key word.
Beyond that it is all recommendation. Demand notes for each loan to the company are a good idea. A loan from shareholder schedule is also good idea if there is a lot of activity; however, a general ledger detail report could work if interest is waived and the books are clean.
Hi,
My husband and I opened a new S-Corp to purchase the assets of my brother-in-laws business (his S-Corp).
There was minimal physical assets such as shelving, pallet jacks, a little inventory etc. The purchase was mainly for the business brand name, website, customer base.
We purchased this for $40,000 with $20,000 down. We paid the $20,000 downpayment from a personal home equity line of credit that we have and have also used this line of credit to purchase inventory for the corporation.
Now that we are building the business back up, the corporation has money coming in and has a corporate checking account. This account pays my brother-in-law monthly payments for the balance of the purchase and buys the inventory most of time. Somethimes I still use our personal line of credit to purchase inventory or put money into the business if needed.
My question is what is the best way to set this up in Quickbooks since we, the shareholders, put in personal money and what about accounting for the payments & interest to our personal line of credit?
Is all the personal money we put into the Corporation considered a shareholder loaning money to the corporation? If we then take money out of the Corp. can this just be considered a loan pay back?
I would appreciate your help.
Thank you
Wendy
I apologize. After re-reading your article, I see that is did answer a few questions I had written in my above post.
If I understand this correctly, I should draw up documents showing the money that I loaned to the Corp. and have the Corp. make monthly payment to me. So I would then pay my personal line of credit back out of my personal money. Am I correct?
The article states that the money we personally put into the S-Corp. can be classified as either a Capital Contribution or a Loan and if we take money out of the Corp. it would be considered a loan pay back or a distribution.
What is the difference , as far as tax purposes, in setting this up as Capital contributions or Loans?
If you have any other advice on setting up the books for my circumstance, I would appreciate it.
Thank you
Wendy
Yes, you are correct on your first question. The ideal way to handle it is to have the documents supporting loans to the company, have monthly payment made to you from the corp, and then pay the loan/creditline personally.
The whole capital contribution vs. loan from shareholder issue has a lot of complexities and there are good points on both sides. However, the thing to keep in mind is that once you make an additional capital contribution, it is permanent for the most part and it can cause excess distribution problems in the future if the funds are distributed. Most of the time, the loan from shareholder should be used – especially when you are dealing with personal loans and cash contributed to cover cash flow.
Few questions:
Sub S shareholder incurred business expenses on personal credit card. I set up a credit card acct on QB and tracked activity.
When it comes time to pay credit card, client did either of the following:
paid directly from Corp checking acccount to credit card (debit CC acct , credit cash in QB) ;
paid credit card directly from personal checking account (debit cc acct, credit s/H loan acct in QB);
or corp wrote check out to S/H who then deposited and wrote check from personal (debit S/H loan acct, credit cash in QB; then debit cc acct, credit S/H loan acct in QB).
Does this sound reasonable? i guess the reason I have it recorded like this is so I can easily match up the liability in QB to the credit card statement (even though credit card is in personal name, it is used 100% for business)
Does this credit card activity increase loan basis?
What happens to my credit card balances if they are discharged in the S/H banruptcy (cards are actually in S/H name)?
I have an S-corp and over time have paid expenses of the company. I also use Quickbooks. Each time I pay expenses for the company using my own money, I have not always reimbursed myself. Instead, what most often has happened is that I have gone into my checking account and used it as sort of a journal entry system of going into the split accounts, itemizing the expense(s) such as for office supplies, and then whatever is the total of those itemized expenses I put in the same total as a negative number for Payable Shareholder. For example, $100 under office supplies and -$100 under Payable Shareholder with me as the vendor — this brings the actual amount in the checking account to zero but puts everything in the right spot in my books.
The problem with this is that now I have >$40,000 in Payable Shareholder. And, each time I write myself a regular check (not payroll check) from my bank with the “expense” being Payable Shareholder, it doesn’t actually end up being an expense. Instead, the Payable Shareholder is reduced on my balance sheet but I get no benefit on the income statement. At year end, this can throw everything off and cause me, depending on the year, to owe tax because my income wasn’t reduced with the Payable Shareholder payment. This can make me pay tax twice on the same money.
Solution?
Brian,
We recently converted our C Corp to an S Corp. We had loaned the C Corp 30K cash, to pay of debt (on a credit line), figuring the Promissory note to us is better than paying the bank. The note requires interest only payments, and is written up with a business law software (so has all formal Promissory Note paragraphs) and is in our corporate records book.
We have been paying the interest on the note.
After our accountant converted us to an S Corp, we have no more loan (the category is there, but no amount). When questioning our accountant he was very perturbed, which was odd, but insists that “loans are a thing of the past” and that Contributions/Distributions is how things will work from now on.
I get that. And I understand, also, that amounts above 10,000 should be written up as loans as opposed to additional cash paid in (to Contributions).
So my question is, how do we carry forward the 30,000, in an account, as debt basis as it was on our previous books as a Long Term Liability (or should it just be a Long Term Liability)
I suspect in closing the old books, and opening the new books there was a problem balancing the balance sheet as our assets have been depreciated to zero book value and yet we still have the note?
So what account would the note balance against?
Thanks for your reply, I read a previous post, too which said it depends on whether there debt basis has been consumed by previous losses (which is confusing to me, as we were a C Corp before, and now have crossed the threshold over to S Corp)
Thanks for your reply,
Marty Mazurik
Portland, Oregon
In 2008 my three partners and I invested 20K each into the company. We entered it as a liability in the company books. We have all decided to forget about the return of the money. How can I reverse this in our books so the liability no longer shows up? Is this possible?
I have the same question as Therese above. How can I get my shareholder loan repayments in QB to reduce my income, so that I don’t have to pay taxes on money that is being used to just reimburse me for what I gave the company originally?
Ex. in 2008 I loaned $100K to the company (S corp), and that year we have no net income.
in 2009 we have 200K in net income. I want to repay the 100K to myself tax free and then take the remaining 100K in salary and dividends, which I would of course pay taxes on.
Where on the Schedule K-1 (S-corp) do I report Interest income received from s-corp to shareholder? This is a loan from shareholder to s-corp.
I opened S-corp in Feb of this year. I have been working as DBA since last year October. Now For the initial two months of the year ( i.e. Jan and Feb 2010) I received three check (worth more then $15000) on my personal name and put them into my personal account. Since March 1 I am putting all the money in S-corp’s account but the checks I am getting are still in my name. From next month I will get it in company’s name. I following questions
1. How should account the initial checks I deposited into my account? Can I take them personal loan from the Company to me? Should I do the quarterly tax return on this from My side as well as company side?
2. I am planning to take salary of 60000 Per annum for me and 10000 Per annum For wife for her service as accountant. Is that OK for the expected income of 120000 or can I reduce that?
I am 100% owner in S Corp on the cash basis. I have put approx $76K into my business over it’s 4 1/2 year life. Accountant classified it as a a loan from shareholder. The business has been unprofitable, RE is negative $54K. Accountant said repayment of loan has to be interest first, if no interest is paid then no interest can be deducted. I don’t need the deduction and would rather forego the interest and pay down principal or reclassify the loan as paid in capital. Can this be done and how? Can the previous interest payments be undone and applied against the principal?
Hi,
My employer takes substantial S corporation distributions through an expense account. I have my doubts and I think this is fraudulant accounting because this Distribution account (classified as an expense account) includes credit card charges for the Shareholder’s children for personal items as well distribution checks. The children are NOT shareholders. There are NO legitimate business expenses categorized in this account. How can this be? Wouldn’t this mean the Shareholder is paying all of the taxes on the distributions, when both he and his children are the ones reaping the benefits? Why would the Shareholder be so generous in that sense? He’s generally a penny pincher when it comes to running the business. These distributions amount to approx 400K per year. I was told the shareholder might be reclassifying these “expenses” to a distribution account prior to filing taxes. I understand that expense accounts have an impact on the P&L, and distributions have an impact on the BS. So how can there possibly be a reasonable explantion for this type of accounting?
Thanks for your help!
Hi , I have S corporation my question is. The profit that you make at the end of the year do you have to pay the shareholder (myself100%), or can you leave it as capital for the bisiness? And not pay taxes. Thank you.
You have to pay tax on taxable net income whether you took distributions or not, so yes – it can be left in the company and then distributed when needed.
Hi. I owned an S corporation business and sold the shares to my stepson in 2004. I also own the land that the business in on and he pays monthly rent. He ran the company into debt and because he never fully paid me for the shares, I got the company back. #1-is the corporation responsible for the credit card debt and line of credit debt that he incurred and how does it pay it or is it his personal responsibility? #2-after looking at the books, I see that he has been taking monthly distributions, no salary, and has not paid me full rent for this year, he owes me 30K, is he allowed to do that and can I recover that debt from him? thank you
Brian – Paid 1040ES taxes 2009 from Scorp account -so appears this was a loan to shareholder. Taxman journalized as Shareholder Distributions (Debit) $xxk and N/P Fed Est Taxes (Credit) $xxk – both are equity accounts. Scorp made profit in 2010. I want to clean up books before 2011 tax season and get rid of N/P.
Have not distributed k-1 for 2010 – is there a way to apply k-1 distributions against the N/P? or should shareholder reimburse Scorp with persoanl check and then Scorp do k-1?
We are a S corp and have loaned the corp $20,000 when business was slow and creditors needed to be paid and this last year we made notations on the draws as being loan reimbursements. My question is are these amounts to be included as wages in figuring the federal tax deposit payment?
Are the requirements you spoke of the same if the business is an LLC electing to be treated as an S-Corp? When does making that election make you have to follow the rules of an S-Corp?
MY HUSBAND AND I OWN A SMALL S CORP. LONG STORY SHORT LOANED MONEY NOW HAVE TO CLOSE BUSINESS…HOW DO I REPORT THIS UNPAID LOAN ON FINAL RETURN AND CAN I RECOUP ANY OF LOAN AS A LOSS ON MY PERSONAL RETURN
It really depends on the full circumstances, and you would definitely want a CPA or licensed tax preparer to prepare the corporate and personal returns, but typically there are no additional losses allowable upon closure of an S Corporation with outstanding shareholder loans.
It may seem counter intuitive, but here is how it works:
You loaned money to the S Corp in order to pay for expenses and/or depreciable fixed assets, which likely gave you tax basis in the corporation and allowed you to deduct the flow-through expenses and depreciation on your personal returns in prior years. By deducting these expenses and depreciation on your personal return, you already received the benefit from the loans you made. Had you not made the loans and instead used credit card or third party loans in the name of the corporation, you likely would not have had tax basis and would have had suspended losses.
When the corporation closes, your CPA and/or tax preparer will close out the accounts and calculate final remaining tax basis. In most cases, it all nets out and there is no remaining basis left because of the losses taken in prior years. Now, every situation is different and there are a lot of complications, but on average, the most common outcome is that there are no additional losses from closure of the business when the shareholder loans allowed for the full deduction of flow-through losses in prior years.
Again, use an experienced professional to prepare the returns and make this determination.
I am trying to figure out how to reclassify a loan to shareholder on the books. 100% shareholder in S.Corp company. Shareholder took out $30,000 in loans from company in addition to taking some salary during the year.
The 30,000 that was taken out of the company was added on to his personal tax return as wages in addition to the salary taken on his W-2. No basis in the company. There was a loss, so it can not be classified as a distribution. This was done for 3 years prior before I came into the company. My question is do I deduct the $30,000 from the shareholder loan and add it to wage account ? and do the tax returns need to be amended since the “loan to shareholder” on the tax returns just keeps growing because no year end adjustments were ever made. (Seems like common sense to me if the shareholder loan was added on to his wages, he had to pay taxes on that money so he shouldn’t have to pay the company back again, am I correct ?) The CPA that did the tax returns has retired and can no longer be contacted.
Wow, what a mess…I cannot believe this return was actually prepared by a CPA! Good thing they retired. Sorry you inherited this.
Amendments of the prior year returns would likely be needed, but it just depends on how everything was reported on corporate side. You cannot claim a current year deduction to clear the loan balance, as the IRS ties out wages closely to payroll tax reports filed. That would just be asking for a notice from the IRS. Plus, with messes like this, you always have to go back and review prior year returns closely to make sure a deduction has not already been taken in some form or another.
The shareholder claims they reported this additional amount as “wages” on their personal returns, but normally such a payment would mean you would have a deduction on the corporate side. From what you have described, it sounds like there was no deduction made on the corporate side, and that the amount of the accumulated “wages” reported on the personal return is in this loan account. Now, in no way do I understand the logic of this shareholder or their tax preparer, but it is what it is. To fix it, you could go back and amend each year affected and claim a deduction for these “wage” payments. Since the payments would not have been reported on payroll tax reports or W-2s, you would have to call them director fees. The amended 1120S returns would result in amended K-1s, and the shareholder would have to amend their personal returns as well. Hopefully, all years are still within statute of limitations, but that third year could be an issue and then the shareholder could miss out on a refund (if any).
There are many bad outcomes with this, as the IRS could really go after the shareholder. First off, they may have picked up the “wage” amounts on their returns and paid normal tax, but they likely did not think of self-employment tax. With director fees, they are going to want SE tax, so they could owe some tax to fix this, but could be worse. If IRS argued it was un-reported wages, there could be some big penalties, as the 941, 940, state returns, and W-2s would have been wrong and under-reported. Not many good options with this mess…
There are also a few short cut approaches that could be taken depending on all the circumstances. Get a new CPA involved soon to get this cleaned up.
Thank you so much for your reply, I’ve been banging my head against the wall with this.
I have worked with many CPA’s in my time and I have NEVER in my life seen taxes done like this. There was a 3 year period where the company was dormant (2004-2007) and when the new CPA did the 2008 taxes is when everything went haywire. That’s when I came into the picture. The books were not kept properly at all for “years” and I had a mess on my hands, I did the best I could with what I was given. The CPA NEVER asked not one question, knowing that I was thrown into the situation, knowing the numbers did not add up, just did the taxes, here you go, no explanation. I tried to get him to explain it to me but it just didn’t make any sense. We didn’t file the 2008 taxes till 2012 so we are still within that 3 year time frame.
The CPA did add the loan to his personal taxes and had him pay SE tax. What I don’t understand is that he only had 130K in sales (not profit) that year but the tax return says he took out a 148K “loan TO shareholder”, that’s not even remotely possible, if you don’t have the cash, you can’t take it out of the company. He couldn’t get the worksheets to balance, didn’t ask me one question, so he just threw it to “loan to shareholder” to get it to balance and get the tax returns done.
You are correct. There is no deduction on the corporate side for him adding the loan to his wages and the wages are still on the loan amount. The owner is owing tax on his personal taxes for all these years. My only problem now is trying to find a CPA that isn’t like our last CPA and will work with me to try and figure this out.
Thanks again ! (at least now I know I’m not crazy !)
I work for an one owner S corp. Many personal expenses are charged on the corporate credit card. Outside of gas and tolls, how do I classify the personal expenses?
Very helpful page, thank you!!!
The personal expenses should be posted to “distributions”, which is an equity account that reduces retained earnings. If you post all personal expenses to this account, your tax preparer can then record it correctly on the tax return and make the determination as to whether there is sufficient shareholder basis to claim the total amount of distributions. Sometimes, a portion of the distributions have to be reclassified as a loan to shareholder if there is not sufficient basis, so just make sure they explain any such reclassifications to you. Also, if they adjust your distributions account when preparing the tax return, make sure they explain their adjustments to you.
I am the bookkeeper of an s-corp with 3 shareholders (60%/20%/20%). In 2011, the majority owner loaned the corporation money in oder to continue operating. At the time the loan was recorded as additional paid in capital, even though we expected to repay the loan prior to any other distributions once cash flow returned. No documentation was done and no interest was ever mentioned at the time. Once the industry recovered and cash flow returned (2014) the majority owner is now requiring 6.5% interest back dated to 2011, along with monthly payments. The other shareholders and I disagree with the way the majority shareholder is requiring me to record the transactions. I have recorded all payments (principal & interest) as distribution, since the original transaction recorded went to “additional paid in capital” rather than a loan because at the time his banker suggested not increasing the liabiities due to business related loans, along with his personal related loans maturing. So in 2011, the transaction was booked to appease the bank and now he is wanting to record the interest payments as an interest expense and issue a 1099 on those amounts, mentioning he had interest expense to offset on his personal return.
My issue is if I record as interest expense in 2014 I believe this expense throw up a red flag since the balance sheet does not reflect a loan of any kind much less a non existant loan from a shareholder ever being recorded. These transactions are clearly based on personal gain from year to year depending on his situation and since he has controlling interest, what he says goes.
He stated that the business is in jeopardy of losing their S-Corp status due to disproportionate distributions and thats is truely why he is requesting the interest payments be classified as interest. He is correct in saying disproportionate distribution amounts will raise a question with the IRS. Legally, the disproportionate distributions would lead the IRS to think the corporation could have a second class of stock. An additional class of stock is a clear valilation and would revoke the S-Corp status. But, surely after further research the IRS would see only one class and dismiss any further investigation. Right?
Please advise me on how you would handle recording the interest payments for 2014. Why?
Also I would appreciate your thoughts on the disproportionate distributions revoking the S-Corp status.
I feel this is ethiclly wrong not only for tax purposes but for the other shareholders as well, and I plan to debate him on this issue even if it means my job.
I agree with you on this. If it was treated as additional paid-in capital on the prior returns, then that is what it is. You cannot simply re-categorize the transaction in a later year. I understand his frustration since it was the bank that required it to be treated as a capital contribution rather than a loan, but you cannot keep one set of books for the bank and one for tax. If concessions have to be made to please the bank, you have to deal with consequences down the line and adapt.
So moving on then, we have no loan, so we cannot record interest. If we pay him an amount equal to what would have been the interest, we run into disproportionate distributions, so we have some options:
1) just reclassify the disproportionate distribution to loan to shareholder. This is a temp solution, and if the disproportionate amount is under $10k, no interest is required on the loan. Going forward, you would have to find a way to eliminate the loan, but at least it buys some time and gets him the money.
2) pay the amount to him as wages. Sure, it is costs a lot more in tax, but it solves the disproportionate issue, and it is really the only other option since interest cannot be paid on a non-existent loan. Plus, the payroll tax is a small price to pay for being able to maintain bank financing during the downturn.
I suppose you could also get creative if the shareholder rents to the company, has a business auto, or receives similar payments from the company. You basically would increase these payments temporarily to move the interest-equivalent out of the company and it to his hands without paying payroll tax. You could even look at shareholder expense equalization (if they equalize certain preferential expense like travel, m&e, computers, devices, etc). If you could find a way to give him a disproportionate benefit, then it gets the interest equivalent to him as well.
If my S corp loans me $10,000 ( a 50% partner shareholder) is that an expense to the Corp? If so That would lower the net profit. which would would lower both partners K-1 distributions by $5,000. Is that correct.
If the S Corp loans funds to you, that is actually interest income to the S Corporation and non-deductible interest expense to you. You would have to have a loan TO the S corporation (from shareholder) in order to have interest expense on the corporate side. However, remember – interest expense for interest paid or accured on your loan is interest income to you. You cannot claim the expense without picking up the income on the personal side.
On our balance sheet is shows a Shareholder loan receivable of a large amount. Interest has been accrued on it each year. The loan arose from the passing of one shareholder and the company was owned 50-50 by husband and wife. The wife became the sole shareholder and put all the life insurance and additional funds into the company to keep it afloat. These were classified as contributed capital. As she needed personal funds, they were withdrawn and since there was never really any basis as the company has operated at a lose for many years, lot coming from large deprecation issues, her withdrawals were listed as the Shareholder loan receivable. There is still very little equity in the company but it is getting closer to starting to turn profit. How would we go about removing this receivable from the books? Would the she need to claim this amount as income? If she does is it bad debt to the s-corp? She does not have the funds to repay it but we would like to clean the books up going forward as her children would possibly like to come on as owners and have a clean start. Thank you so much!
HI there, I am not sure you are still checking this thread, but I am curious on how to handle loans from a prior shareholder. When the shareholder of the S corporation, a substantial amount was “taken” from the Corporation and recorded as a note receivable. This was presumed that the existing shareholders would try to seek payment. Now they are 1.5 years out from that shareholder “leaving” the corp, and they don’t know how to handle a $600K receivable note. How can the note be taken off the books if it is not collectible?