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S Shrholder Loan Basis


Randall

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S Corp shareholder paid part of his shareholder loan back.  Still has remaining loan basis.  The 1120S K-1 basis statement shows the reduced loan basis.  Loan basis was restored by profit.  On the shareholder 1040 basis worksheet, part of the loan repayment is showing as reportable income.  I can't determine why this doesn't match the 1120S basis statement and not show any part as taxable income.  I seem to vaguely recall that loan repayment is considered done during the year while profit restores basis at the end of the year.  Is this so and why ATX is calculating a part of the loan repayment as taxable?  And if so, is there anywhere in ATX, I can see how this is calculated?

 

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I think your problem is that, as you said, the loan has a reduced basis during the year when repayment occurs and the loan basis may have been restored at year end.  The repayment with loan basis at less than face value does create taxable income to the shareholder, and its character is dependent on the loan itself.  If the loan has been formalized with its terms then the income triggered by repayment will be capital gain. If, on the other hand, if the loan is open ended and not formalized, then the income from repayment will be taxed as ordinary income. 

This is an older article from Journal of Accountancy that is still on point and has more detailed explanations with code and reg references that helps to explain it, starting with the paragraph immediately before the heading "When Debt Basis Is Gone" through the end of the article: Avoid the Tax Trap When Repaying Shareholder Loans

I also found this CCH KB article,  that also describes the formula of how it handles debt restoration and the "net increase". It also talks about checking a box if the preparer desires to have the debt basis restored before loan repayment, contrary to the regs.  I also see that it may be linking to the same article I provided above but its link is not working. I am not sure how current the KB is, can't find a date on it, fwiw:   How do I treat shareholder basis loan repayment versus net increase for year?

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37 minutes ago, Abby Normal said:

I don't allow my one shareholder or two married shareholders to have loans payable. They usually don't rise to the level of a real loan to start with. I move it all to equity, because I'd rather just deal with stock basis.

Probably a good idea.  For this one, I inherited it.

 

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I figured out how ATX is calculating the taxable portion of the repayment.  But the 1120S K-1 basis statement will be off from the 1040 basis worksheet.  The 1120S is showing the entire amount of the repayment reducing basis and the 1040 is only showing the nontaxable portion as reducing basis.  Remaining loan basis is greater on the 1040 worksheet than on the 1120S basis statement.  Is this difference something I am going to have to live with?  What if they go to someone else in the future or I retire (not too far off).  I would like the two to say the same thing.

 

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21 hours ago, Abby Normal said:

I don't allow my one shareholder or two married shareholders to have loans payable. They usually don't rise to the level of a real loan to start with. I move it all to equity, because I'd rather just deal with stock basis.

And now with TCJA, when corporation goes belly up, they are no longer able to write off as misc itemized deductions as corporate employee per case law.

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43 minutes ago, OldJack said:

Capitalizing a shareholder loan to a C-Corporation is never a good idea as the shareholder can't just take the money back out tax free.  Any distribution from an equity account has to be at fair market value of the corporation with taxable gain.

They were never really loans, and I always catch them in the year they happen and record them as additional paid in capital.

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>They were never really loans, and I always catch them in the year they happen and record them as additional paid in capital. <

Other than a convenience for you please explain the advantage for the owner/shareholder. Please explain how the owner gets his money back tax -free if he wants it from a C-corp.  Please tell us it was the C-corp owner/shareholder that made the decision to capitalize.

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With regards to capital which includes paid in capital there is no difference between a C or S corp.  S-corp is not a partnership where capital can generally be returned tax free.  S-Corp distributions of “AAA profits” pass tax free is the ONLY difference from a C-corp.  Distribution of S-corp capital is subject to capital gain the same as a C-corp. 🙄

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My understanding has been that if there are no E&P (which is the case for most of my clients) then paid-in capital CAN affect the taxability of the distribution because it will increase the stockholder's basis and therefore could be distributed as part of tax-free distributions. If, however E&P exists, then the taxability of the distribution is determined with reference to AAA, which does NOT include capital contributions. I looked for some guidance and found this in this article (https://www.forbes.com/sites/anthonynitti/2014/04/08/tax-geek-tuesday-are-those-s-corporation-distributions-taxable/#71dcc8d06a22) in Forbes: 

Stock Basis

... A shareholder must increase the basis of his S corporation stock for capital contributions, items of income (including tax-exempt income), and the excess of the deductions for depletion over the basis of the property subject to depletion....

..Of utmost importance is the order in which these adjustments are required to be made. This is because while distributions reduce basis, in many cases, it is the shareholder’s stock basis that will in turn determine the taxability of a distribution...

Accumulated Adjustment Account

...The maintenance of the AAA is critical when an S corporation possesses accumulated E&P because it is the AAA balance that will serve as the line of demarcation between those distributions made from S corporation income, which should not be taxed a second time, from those made from C corporation E&P, which must be taxed as a dividend to the recipient shareholders. The larger the AAA balance, the more likely a distribution will not be taxed as a dividend.

Each year, an S corporation must adjust its AAA in a manner similar to a shareholder’s required adjustments to stock basis. Unlike stock basis, however, the AAA is a corporate-level attribute and is generally not affected by shareholder-level transactions like sales or exchanges.

Specifically, an S corporation increases its AAA for the same items that increase basis, except AAA is not increased for capital contributions or tax-exempt income. Similarly, AAA is decreased for the same items that decrease basis, except for non-deductible expenses related to tax-exempt income.

Unlike stock basis, AAA may be reduced below zero, but only by losses, not by a distribution....

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I have no disagreement with what jayla248 posted.  The adjustment of stock basis is at the level of the shareholders personal taxes not at the S-corp book accounts, although the corp may keep track of it for the shareholders.  

For taxation a S-corp is the same as a C-corp except for taxation of taxable pass-thru income/loss.  S-corp distributions in excess of the AAA account requires a filing of a 1099-D showing a dividend or stock distribution-as the case may be.  A corporate AAA book account may show a negative balance but not for purposes of personal shareholders deduction calculation.

When “capital” is distributed it is at fair market value (appraisal value) of the Corp verses personal stock basis resulting in capital gain or loss at the shareholders personal stock basis (same as C-corp). 

[Example: book value of building is zero but market value is one million therefore FMV v. Stock basis=gain just like sale of stock]

Contributions (paid in) to capital increase shareholders personal stock basis but cannot be returned (v. Loan) without being classified as “capital” distribution at fair market value.  Paid-in-capital is shown as separate book account only to distinguish between par value stock accounting.

Loans should be documented and never be capitalized as that is what the IRS wants to force capital gain tax when taxpayer decides to take his loan back without telling you! 

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There can be advantages and disadvantages of either a shareholder loan or contribution of capital by the S corp shareholder.  

As pointed out the capital contributions will increase  basis and distributions will decrease basis rather than triggering income, absence positive AAA or AE & P.

On the other hand, if debt basis has been depleted, repayment of the debt can result in taxable income.

The key is to inform (and document) the shareholder of the possible  impact of either injecting capital or loaning money to the corporation; keeping in mind the consequences if the company goes under.  In that situation, the stockholder might be better off holding 1244 stock resulting in an ordinary loss.

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OK lets use a simple example. 

1. Corp has from day 1 been an S-corp.

2. Corp issued 100 shares of "no par stock" for cash from sole shareholder for $10,000. ($100 per share)

3. Sole Shareholder contribute additional $10,000(*) capital in order to buy land.  100 shares Stock Basis $20,000, no par ($200 per share) 

4. Corp has made a profit for rent every year and has distributed exact profit at year end.  No AAA balance.  No other assets except land.

5. Corp has land with $20,000 NBV and FMV of $500,000 due to location. (FMV 500,000/100=$5,000 per share FMV)

6. Corp distributes $10,000(*) capital to shareholder. (same as shareholder sells back to corp  2 share @FMV $5,000 for $10,000. 

7. Taxable gain to shareholder: Proceeds $10,000 cost basis ( 2x$200) $400 = $9,600 taxable gain.

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@Abby Normal Do you think the distribution of S-corp assets (ie: automobile) at cost basis are tax free distributions {hint it has to be at FMV}?   S-corp status only pertains to AAA distributions and the effect it has on the shareholders personal taxes.  A S-corp is a C-corp that has elected to be taxed under special S-corp statutes for current income attributes (AAA) only.  Violate the S-corp statutes and you are automatically returned to C-corp status.  Yes distributions of AAA account is tax free because the shareholder has to declare and pay the tax,  but distributions in excess of AAA are C-corp dividends or C-corp capital distributions that was not passed through.  The Corp must file 1099 for distributions in excess of AAA as such capital distributions are not AAA reported on the 1120s-Sch-K1. 

Basis for tax calculation is only at the personal tax level not at the corp level.  A corp "book account of the AAA" can have a zero balance just not for purpose of the personal tax basis calculation.  Tax Seminars don't teach accounting. 

Why aren't you people helping Abby understand?

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Perhaps because it is my understanding that AAA ( not always the same as basis) is irrelevant unless E&P exists and I agree with Abby.   If the Corporation elected S from day one, then there is no E&P.  Please see the article below that gives a pretty clear explanation. 

https://www.forbes.com/sites/anthonynitti/2014/04/08/tax-geek-tuesday-are-those-s-corporation-distributions-taxable/#51ea0396a22e

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Taxability of Distributions from S Corporations with No Accumulated E&P

Section 1.1368-1(c) provides that in the case of a distribution by an S corporation which has no accumulated E&P, the distribution is taxed under a two-tier approach:

1. First, the distribution is a tax-free reduction of the shareholder’s basis in the corporation’s stock; then

  1. Any distribution in excess of the shareholder’s stock basis is treated as gain from the sale or exchange of the underlying stock.

Noticeably absent from these rules is any reference to the S corporation’s AAA balance. This is because the AAA account serves to provide a dividing line between those distributions made from previously earned but undistributed S corporation income, which should not be taxed a second time, and those made from prior C corporation E&P, which must be taxed as a dividend. If no accumulated E&P is present, this dividing line is unnecessary, as it is not possible for a distribution to represent a taxable dividend made from E&P. Thus, in determining the taxability of distributions from an S corporation with no accumulated E&P, the AAA balance is completely irrelevant; rather, the only attribute of consequence is the shareholder’s basis in the corporation’s stock.

(This is my understanding as well. But then my abnormal brain can only handle so much complexity. 🤓)

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10 minutes ago, BHoffman said:

Perhaps because it is my understanding that AAA ( not always the same as basis) is irrelevant unless E&P exists and I agree with Abby.   If the Corporation elected S from day one, then there is no E&P.  Please see the article below that gives a pretty clear explanation. 

https://www.forbes.com/sites/anthonynitti/2014/04/08/tax-geek-tuesday-are-those-s-corporation-distributions-taxable/#51ea0396a22e

AAA & E&P is the confusion.  We are not talking about the distribution of S-corp income.  We are talking about Capital distributions. OK example:  S-corp never had a loss, No E&P, No cash, distributes all AAA income every year end and now liquidating "property distribution" of land with book value of $20,000 and FMV of $500,000. What is the tax to the shareholder with outside stock basis of $20,000.  If it was a proprietorship it would be no tax effect but as a S-Corp or C-Corp??  Geez

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From the article referred to by BHoffman

quote:

>>S Corporation Distributions, In General

Pursuant to Section 1368, a distribution of cash or property by an S corporation may give rise to three possible tax consequences to the recipient shareholder:

  1. The distribution may result in a tax-free reduction of the shareholder’s basis in the corporation’s stock,
  2. a taxable dividend, or
  3. *Gain from the sale of the stock (generally resulting in capital gain).

<<

Item1: You guys are confused with adjusting the shareholders basis which I agree with Item #1.  Yes AAA distributions and allocation of AAA income effect shareholder basis.

Item2: If no E&P this is not an issue per my example.

Item3.  *This is the issue!  Cash or Property Distribution in excess of the AAA from the Corp books is a Capital distribution at FMV the same as a sale of stock.. 

Example:  Try to give stock as a gift without FMV gift tax classification transaction.  Try to sell stock to related party at shareholders cost basis (IRS will give you a tax bill at FMV).  Distribution of Property if no AAA balance is treated as a capital sale.

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