C-Corp Basis

[Max W]

New client with C-corp and 3 years due. The 2012 1120 Balance sheet shows $500K Loans from shareholders, zero capital.  From talking to the client the loans were more like paid in capital as there is no loan paper between the corp and client and no interest changing hands.

Is there any reason the "loans" could not be re-characterized as Paid in Capital on the 2013 and subsequent returns?    This could be a major issue because of large NOL's.

TIA

 

 

Edited September 1, 2016 by Max W
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[rfassett]

I would do that only after receiving written instructions from the client so you have a CYA document in your file.  The document can be as simple as:  it is my intention to convert the Loans from Shareholders on the books of XYZ Corp to Paid in Capital on the books of XYZ Corp, effective 01/01/13".  Or something like that.  But for you to just do it on your own is wrought with liability disaster.  Oh - and my comment assumes only one shareholder.  If there is more than one shareholder, then the document should state what each shareholder's amount of conversion is and the document should be signed by all shareholders.  This should also be noted in the minutes of the Corp.

Hope that helps!

[Max W]

Thanks, rf, it does help.  The previous CPA was remiss in not insisting that the loans be formalized and interest paid.  For 2012 the interest @ 6% could be as high as $30K.  Since substantial NOL's have been taken and will be taken, the lack of basis, if the loans are not legitimate, could jeopardize the NOL's.

As for the minutes, I haven't determined that yet, but I'm doubtful that any yearly stockholder meeting was held as there is only one shareholder who has 100% of the stock.  However, I was only able to talk to her husband who manages the business and handles tax matters.

 

[rfassett]

I am not suggesting that there would be anything in the prior minutes - that may or may not exist (I get that).  I am suggesting that the document that is currently being prepared - note of that needs to be put in the minutes.  Tell the shareholder he needs to have a meeting with his board (which is probably he and his wife) and have the board enter into the minutes that the loans should be converted to paid in capital as of 01/01/13.  And date the minutes the day of the meeting.  I do not see any good EVER of pre-dating documents.  Nothing good can come of that.

[rfassett]

Oh - and you might want to have them put something in the minutes about "our new accountant (and make sure they mention your name) discovered some anomaly in the prior year tax returns and the proposed adjustment is being made to fix those".

[Max W]

Very good suggestions. I appreciate your help. Thank you.

 

[OldJack]

I disagree with capitalizing the loans.  Obviously there should be some capitalization for the issue of shares of stock which is really the problem.  Issue of shares of stock can be booked even with an account receivable from the owner.  Obviously the loans should be documented and subject to interest.  The problem with capitalizing the loans is that the IRS considers a return of capital only qualifies for tax free distribution if all retains earnings have been paid as taxable dividends first.  So in effect you may be locking in those loans making it difficult to distribute in the future.  That can make your client very unhappy.

[OldJack]

10 minutes ago, OldJack said:

I disagree with capitalizing the loans.  Obviously there should be some capitalization for the issue of shares of stock which is really the problem.  Issue of shares of stock can be booked even with an account receivable from the owner.  Obviously the loans should be documented and subject to interest.  The problem with capitalizing the loans is that the IRS considers a return of capital only qualifies for tax free distribution if all retained earnings have been paid as taxable dividends first.  So in effect you may be locking in those loans making it difficult to distribute in the future.  That can make your client very unhappy.

Also, Check to see if the corp is actually paying interest to a bank when it should be paying to the shareholder as this loan probably came from a financial institution such as a bank.

[OldJack]

I don't understand what a NOL has to do with capitalizing.  A C-corp NOL is carried forward until C-corp income and not deductible otherwise.

[Max W]

2 hours ago, OldJack said:

I don't understand what a NOL has to do with capitalizing.  A C-corp NOL is carried forward until C-corp income and not deductible otherwise.

Doesn't there have to be basis in the corp (either with Paid in Cap or a legitimate loan,) to take the NOL?  There may well be a bank loan to the owner, but the corp is not paying any interest.

As for return of capital, there is also a minus $700K in retained earnings so there is nothing to be distributed.

How would you suggest legitimizing the loans? Some of the loans were made seeral years prior to 2012.

Thanks for your help. 

 

 

[OldJack]

On ‎9‎/‎2‎/‎2016 at 2:29 PM, Max W said:

1.Doesn't there have to be basis in the corp (either with Paid in Cap or a legitimate loan,) to take the NOL?  There may well be a bank loan to the owner, but the corp is not paying any interest.

2.As for return of capital, there is also a minus $700K in retained earnings so there is nothing to be distributed.

3.How would you suggest legitimizing the loans? Some of the loans were made seeral years prior to 2012.

Thanks for your help. 

 

 

1.I don't understand your concern about taking the NOL.  Who are you thinking takes the NOL.  No one takes the NOL except the C-Corp against future profits.  If the C-Corp folds the NOL is lost but the loaner writes off his loans and stock basis as bad debt (on 1040 Sch-D) with the same results as if it was capital with write off of stock basis. Don't confuse a NOL of a C-Corp with that of an S-Corp. The NOL is a carryover for the C-Corp.

2.Once you capitalize loans you can't go back to loans (to pay back the loaner).  If the C-Corp has future earnings then you can't take your paid in capital out without paying dividends on those earnings resulting in the earnings being double taxed just to get your paid in capital out.

3.Legitimize with a new loan, that gets rid of the old loans.  The past is the past and you can't do anything about that.  The Corp defaulted on interest unpaid since it didn't have income to pay.  Default is not income to C-Corp and not income to loaner.