S Corporation Shareholder Advances
The IRS recently issued new regulations relating to the tax treatment of loans you make to your S Corporation. These regulations will have a significant effect upon your company and taxes you may owe for the coming year.
Background:
In the past, if you had no remaining tax basis in your S Corporation, you would be able to generate tax basis (and deduct losses) by advancing funds to your company before the year end. As soon as the year had passed, you would be able to take the funds back out of the company with no consequences – as long as the tax basis was restored before the end of the year by making new advances and/or income generation. The IRS calls these types of loans “open account debt”; they are shareholder advances with no repayment or interest terms. You have made advances like this to your company.
This strategy is no longer available to most S Corporation shareholders.
How Does This Effect You:
S Corporation stockholders no longer have the flexibility of lending large amounts to their company’s to create basis for loss deduction and having that money immediately paid back in the next year. Any open account debt that is owed to you, which has been used to deduct losses, must be carefully reviewed before being repaid to avoid triggering income. Even if there will be no repayments made during the year, all shareholder loans and advances should be reviewed. The IRS will treat such advances above $25,000, as separate notes payable. Per IRS Regulations, payments on shareholder notes payable vs. open account debt may generate taxable income. Therefore, you will need to be very careful about advancing money to your company. Unlike past experience; having your company pay you back on your advances may trigger income.
Advances above the $25,000 IRS threshold should be formalized by a note payable.
In the event that the company “did” pay down a shareholder advance and trigger income, formalizing the advance by drafting a note may create a defensible position for such income to be taxed at lower capital gain tax rates vs. higher ordinary income tax rates.
What Needs to be Done:
In the course of preparing the corporation income tax returns we see that you have loans like this outstanding. We recommend that you formalize these shareholder advances, by preparing formal notes. Your legal counsel should be able to draft the loan documents and necessary corporate resolutions providing you protection for the loan. It is our goal to make sure our clients are fully informed and prepared to meet these new rules. Please let us know if you would like us to provide the necessary data to your attorney by either calling our Tax Manager, Terry Martin at 215-675-8364 with the attorney contact information. We very much appreciate the opportunity to serve you.
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