Cash Basis C Corp - Interest accrual?

[miatax]

I have a cash basis C Corp client that has one owner. The company owes the owner about $100k. There is no official note and there has been no interest accrual. Now that the company is good with cash flow, I am recommending he get paid back a part of the loan.

Would it be correct to have the company pay him money WITH interest on the date of payment as the company is on a cash basis?

I know that C Corps on cash basis can accrue the following:

Payroll Tax Liabilities

S/H Loans

I do not recall if it should have been accruing interest for the s/h loan though...

[jainen]

>>There is no official note and there has been no interest accrual.<<

In my opinion, it sounds more like an equity contribution than a loan.

[JohnH]

But it's never too late to do a corporate resolution & some minutes to get things on track, either. Well, as long as the audtior isn't standing at the doorstep.

[Maribeth]

But it's never too late to do a corporate resolution & some minutes to get things on track, either. Well, as long as the audtior isn't standing at the doorstep.

Of course you know that that corporate resolution and the supporting minutes are in the file cabinet and it will just take me an hour or so to find them.

Maribeth

[Catherine]

Of course you know that that corporate resolution and the supporting minutes are in the file cabinet and it will just take me an hour or so to find them.

Maribeth

One of my clients keeps their old meeting records in the attic of one of the officer's homes. So next day would be the earliest they could pull them out.

I'm just sayin'... ^_^

[jainen]

>>as long as the auditor isn't standing at the doorstep<<

Always a very useful attitude, easily adapted to other activities such as driving a car and shopping for small valuables.

[OldJack]

Fact is there is no IRS requirement that a corporation have any resolutions or corporate minutes for anything. However, there are IRS requirements for certain "plans" and in fact it is a good idea to have such minutes. Trouble is that minutes can be used against the taxpayer as well as help the taxpayer. Therefore, be careful about what you put into corporate minutes.

[miatax]

What had happened was that years ago, the company was running into cash flow problems, so the owner gave the company money in a few payments. The owner never really determined whether that money was to be paid back or not. So does it really make a difference whether it is treated as contributed capital or a loan?

It's been reported as loans to shareholders on prior year tax returns. Would it be incorrect if it's reclassified in 2009 as contributed capital and then he is getting back a return of capital when he makes some payments back to himself?

[jainen]

>>What had happened was that years ago... <<

I take back what I said about it sounds like capital. In my opinion, it sounds like a lame excuse to hide dividends. Since the corporate records don't show it as capital, are inconsistent about it being a loan, and only barely suggest the contribution even happened at all, why in the world would a responsible tax preparer be asking such a question?

[miatax]

OK Jainen: Thank for your information. You may be someone who reads IRS publications all day and replies to people in these forums - sometimes correctly, however sometimes with UNNECESSARY sarcasm. What kind of good natured person would take this approach???

I don't criticize anyone and by the way, there are no questions that merit sarcasm. As a college instructor, I would NEVER treat my students that way! Taxes are NOT my forte and so I come to this forum to get help - not to have someone bash a doubt that I have.

'why in the world would a responsible tax preparer be asking such a question?' I don't consider myself irresponsible.

This is something that has been in the books for a while. He gave the company money when it needed it. That's all. It's been sitting on the books for quite sometime (before I was involved) and I just recommended he take some of his money back now that the company is doing well. My question was in reference to the correct classification and any interest. It's a cash basis company and there has been no interest accrued. My question was what is the correct way to treat this.

[jainen]

>>I just recommended he take some of his money back now that the company is doing well<<

Okay, you don't like my attitude, but what about the facts? In my opinion, based solely on what you have stated, the corporation's own records do not support treatment as a loan. So it is apparently capital, but the distribution, in my opinion, looks more like taxable dividends than a reduction in equity. In my opinion, that's kind of the way corporations work.

[OldJack]

>>I just recommended he take some of his money back now that the company is doing well<<

Okay, you don't like my attitude, but what about the facts? In my opinion, based solely on what you have stated, the corporation's own records do not support treatment as a loan. So it is apparently capital, but the distribution, in my opinion, looks more like taxable dividends than a reduction in equity. In my opinion, that's kind of the way corporations work.

Well... I would look at the books and see how the money was recorded when the shareholder deposited it in the company books. I doubt the shareholder intended to contribute capital and intended to take his money back when the company could afford to pay it. It is usually only the IRS that likes to call it a capital contribution. Even if it is capital there are procedures to return capital as tax free.

[jainen]

>>I doubt the shareholder intended to contribute capital and intended to take his money back when the company could afford to pay it.<<

I don't know why you would think that. In my opinion, he himself did not consider it to be a loan at the time, not bothering to make arrangements for interest or even any repayment. In my opinion, the sole shareholder simply invested in his own business plan and now that he's making money he doesn't want to pay taxes on it.

[taxxcpa]

>>I doubt the shareholder intended to contribute capital and intended to take his money back when the company could afford to pay it.<<

I don't know why you would think that. In my opinion, he himself did not consider it to be a loan at the time, not bothering to make arrangements for interest or even any repayment. In my opinion, the sole shareholder simply invested in his own business plan and now that he's making money he doesn't want to pay taxes on it.

Repaying a loan will not reduce corporate income.

The only problem with repaying the loan would be if it had been recorded originally as contributed capital rather than as a loan.

If interest is paid on the loan, it would be of no benefit for a one-owner corporation. It would reduce the corporate income and would increase his personal income--a washout unless the tax brackets were different for the corporation and the individual.

He should have made it an S-Corp and then all this would not be a problem.

[jainen]

>>Repaying a loan will not reduce corporate income.<<

Exactly. In my opinion, that is why this setup stinks. It seems to me that the owner wants to pull out cash, cash he didn't have before the business turned a profit. But he doesn't want to call it profit, he wants to go back and claim there was an undocumented loan so he can take the money tax-free. I think this is a reasonable interpretation of the facts Miatax laid out, but if it is not accurate the owner should address it directly. He calls it a loan, and apparently it "has been in the books for a while." But as far as Miatax has posted he never actually treated it as a loan, he just CALLED it a loan and now wants a tax break based on his own unsupported vocabulary.

Miatax is a college professor so she knows what constitutes credible documentation. In my opinion, she's getting played. In my opinion, the very first question that we should have asked is, "Why did the taxpayer change accountants?"

[BulldogTom]

In the strictest sense, Jainen is correct. Bad recordkeeping in the past has led to this result.

On the other hand, if I looked back on the trial balance and every single year there was an amount coded as a liablity to the owner, and the account title said loan due to the owner, I might be persuaded that this was a loan, that the owner intended it to be paid back with interest, and treat it as such

But the earlier thread says "the owner never really determined that the money was to be paid back or not". That pretty much seals it as a contribution of capital in my book. Withdrawal is a dividend. JMHO

Tom

Lodi, CA

[OldJack]

>>That pretty much seals it as a contribution of capital in my book<<

Hog wash! Unless the books recorded it as a capital contribution it is simply a loan that is not documented in the best form. There is no IRS requirement that a loan be written. There are instead procedures for imputing interest for such loans. This client should simply create a loan document now to clear the situation and pay off the debt.

[miatax]

Thanks Old Jack. That is what I will recommend my client to do. The question then is on a cash basis C corp, is interest recorded on the books only when that payment is made to the shareholder or is it one of the cash basis exceptions that should be accrued? No interest has been accrued on the books and client did get paid back $10,000 in December.

[OldJack]

IRC§ 267(a)(2) says that >>an accrual basis taxpayer [ie:Corp in your case if accrual basis] cannot deduct an expense payable to a cash basis related party until the amount is includible in income of the recipient [ie:shareholder in your case]<<. Obviously a cash basis corp cannot deduct unpaid interest if an accrual basis corp cannot. However, the key here is what is "includible in income of the recipient"?

A shareholder loan greater than $10,000 specifying an interest rate lower than the AFR (Applicable Federal Rate) is referred to as a "Below-Market Interest Rate Loan" [iRC§ 7872(e)(1)]. Such "unstated" interest as calculated by IRC§ 7872(e)(2) or IRC§7872(e)( B )is includible in the shareholders income much the same as OID interest. However, imputed interest under AFR only apply to certain loans, basically those loans connected with the sale or exchange of property, patent rights, annuity contracts, acquisition of 197 intangibles, divorce payments and property settlements payable in installments, and certain other contracts.

As you can appreciate from your research on this subject, this is a rather complicated subject that little guidance (or simple explanations) is offered in publications. Therefore, if this was my case, I would document the current loan with appropriate interest and terms and forget about the past.