S-Corp questions re: loans vs APIC

[DTS]

I am VERY frustrated trying to understand a couple questions regarding areas of loans to an S-corp and paid-in capital and hope some can clarify these two questions for me. I have been spent endless hours trying to research for the answers, but cannot find what I’m looking for.

Taxpayer’s S-corp:
Stock basis: $89,000
Additional paid-in capital or loans: $230,000
AAA: ($52,000)
Distributions: $45,000

Today I read that once a s/h’s money is put into paid-in capital, it cannot be taken out. Why can’t it be taken out? Does this constitute a sale of stock or a taxable distribution to the s/h? The reason I ask is that it seems one could consider it a return of capital, which would reduce s/h’s basis, but this doesn’t appear to be an option.

Also, once a s/h loans money to the corp and very irregular repayments (principle and interest) begin the first year, but no loan repayments occur the following year, does the s/h still have to report the phantom payments as if they did occur and if so, why?

Thank you for taking the time to answer. Your answers certainly will help me understand this better.

Dennis

[John of PA]

Stay away from Loans

I only book money going into an S Corp as a loan if the taxpayer really means a loan and will pay it back as a loan with interest paid. I rarely book loans. I just simply book money going into an S Corp as Paid in Capital, and money coming back out of the S Corp as an "S Shareholder Draw". It that simple. No hassle with loans that the IRS declares not a loan (becasue there was no note, or no interest paid, or no 1099-INT). The answer to your question is when the money comes back out, i'ts a S shareholder Draw.

[DTS]

John of PA

John,

Sandy found this thread started by Natiro from a year ago and emailed it to me last night. It's a great discussion and did answer my question about the loans vs apic.

http://www.thetaxbook.com/forums/showthread.php?t=2959&highlight=contra+accounts

Now, I wonder about my second question regarding irregular loan repayments to the shareholder that have begun, but may not be made the following year. By chance, do you know IF he would still have to report interest, as if he received it, but did not?

Thank you,

Dennis

[John of PA]

Yes

Yes, my understanding is, if it was set up as a loan, interest must be reported (imputed) every year, whether it is paid or not. This is another advantage of steering clear of loans if possible and booking the funds as capital contribution and draws.

[Golden Rocket]

Dennis

The entire matter of "paid-in-capital" relates to the initial purchase, and, unless the corporation is being re-organized, it does not refer to contributions made later.

Every corporation has what is called "legal capital" or "capital stock." There is a hodge-podge of requirements that vary from state-to-state, but the corporation really "sets" the price of its capital stock in its original charter or by-laws.

For example, the corporation may authorize 20,000 shares at a "par" stock price of $3.00 per share. If your friend establishes 50% of the capital stock, that means he furnishes 10,000 shares at $3.00 per share. That means he must furnish $30,000 in cash or other property.

The $30,000 is called "capital stock" and unless he buys more stock, this value never changes, although his basis may vary considerably.

Capital stock is considered "Paid-in Capital." And as you have read, this does not change, but it can be changed if corporation is re-organized, or if he receives a liquidating distribution.

Let's say your client invests $50,000 instead of $30,000. The extra $20,000 is also paid-in capital. But on a balance sheet, it appears as "Additional Paid-in Capital" because it exceeds the established stock price.

I mentioned possible state requirements. It is not unusual for states to prescribe a minimum, but it is usually trivial. For example, most states require a minimum $1000 total of all shares. This can range from 1000 shares @ $1.00 to 100,000 shares @$.01.

Additional contributions are not "paid-in capital" unless more stock is bought. Typical contributions are temporary, and are offset against draws, or converted into loans. And if the loan is not paid within a certain time (e.g. a year, perhaps), then interest must be imputed whether it is charged or not.

Does this help?

[S T]

Pardon my ignorance

So Golden Rocket,

If I am understanding correctly for an S Corp, if additional contributions are classifed as "Additional Paid in Captial" there should be additional shares of stock issued, which would increase stock basis?

Therefore, there can be no withdrawals against Capital or APIC without a taxable event ?

Sandy

[Golden Rocket]

Sandy

...you're on the right track.

If there are additional contributions by a shareholder, they must either 1)credit against draws already charged against that shareholder, 2)be a loan of some length, or 3)be a purchase of additional stock. If you credit additional stock, then you must concede that all of the shareholders intend for their ownership to decrease and the contributing partner increases his share of the company. None of this by itself creates a taxable event.

#3 increases his stock basis, thus insulating himself against distributions in excess of basis and increases his capacity to deduct losses. #2 increases his loan basis, which increases his capacity to deduct losses, but does nothing for distributions. #1 does nothing except technically reduce actual distributions.

If distributions exceed accumulated earnings, then paid-in-capital has to be reduced. In this event, the distribution is a liquidating dividend and is not taxable. For capital stock and additional-paid-in-capital, the additional paid in capital is liquidated in tandem with its associated capital stock.

For example, if Moneybags paid $50,000 for 10,000 shares at $3.00 stated value, then he has created $30,000 in capital stock and $20,000 in APIC. APIC has been created at a value of $2.00 per share. If Moneybags later has a liquidating distribution of $15,000, then 3,000 shares are redeemed. Capital Stock must be reduced by $9,000 and APIC is reduced by $6,000. The formula becomes more "weighted average" if a number of different stockholders have bought stock for different prices, but ALL of them are recorded at only $3.00 per share of capital stock.

[DTS]

Gr,

Your post really did clarify things greatly. I appreciate you (and John) for taking the time to answer my questions with such detail. I know so many on the board are busy right now with the 15th coming next week!

I did read the thread I posted earlier and your posts a few times. I will have some other question at a later time and hope you don't mind jumping to my rescue, again!

I've always been like one of those pesky children that keep asking their parents "why or how come" over and over again. I can never get too much detail to suit me.

Thank you, again! Also, sorry for just now getting back to the board to give my thanks.

Dennis

[S T]

Gr

I, like Dennis, always seem to have more questions.

Thanks GR for your post on the Capital and APIC, and the examples. It really helps!

Sandy

[Golden Rocket]

DTS and ST

...that's why we are such a community on this board. I remember several times Dennis and Sandy were on the board helping me out of a jam as well...

[oceanlovin'ea]

Here is another side of this issue. Many of us have one owner s corporations. Their capital stock is $100 or something like that. A very low figure. They have started these businesses with very little capital and some equipment that is put into corporation. How would you explain the situation you mentioned earlier (Moneybags) when the capital stock is only $100.

And if their distributions that they took during the year amounted to $30,000 but the AAA amount was $28,000, how would you reduce capital stock and APIC?

Thanks for taking time to explain this.

Linda F

[Golden Rocket]

Gaap

Linda, the portrayal of Capital Stock and Additional-Paid-In-Capital is related to mainstream double-entry accounting, and not to tax accounting.

For example, "accumulated earnings" as I used it refers to "Retained Earnings" and not to the Accumulated Adjustment Account. Retained Earnings is simply all the profit the corporation has EVER made, less all distributions of profit (dividends).

There may be several reasons for a client who shows $100 in capital stock:

1) It could be a mistake. If you're looking at a balance prepared by someone other than a CPA or experienced accountant, it could very well be a mistake.
2) Your state may allow "no-par" stock. This allows the corporation to simply accept whatever money is initially paid for the stock without declaring a price.
3) Your state's statutory amount of minimum capital stock may be very very low. $100 is very very low.

If in fact, your corporation has only made $28,000 profit since its inception, only has $100 in paid-in-capital, and there have been $30,000 in distributions, then you would have $28,000 in dividends, $100 in liquidating dividends, and a $1900 loan to the shareholder.

[S T]

Question on Dividends S Corp

Never a C corp before, S Corp has ordinary income of $85,000 and AAA shows ending balance at 75,500, so when do you distribute this amount as a dividend?? Doesn't a 1099 DIV have to be issued?

Isn't the shareholder paying taxes twice, once for the $85,000 ordinary income on K-1 in 2006 and then again as a dividend say in 2007?? Aren't there some ordering rules as to how the distributions are made? In the above example, there were some loan repayments, of course not as much as what the AAA balance is. .

I am lost!

GR would you consider offering tutoring on S Corps? You seem to have so much knowledge. I for one would travel to you for private tutoring!

Sandy

[Golden Rocket]

No tax treatment

Sandy, all of the conversation on paid-in-capital (and balance sheet treatment of same) is from the perspective of general accounting and not tax accounting. Since taxes are not a factor, paid-in capital is reported the same irrespective of C Corp/S Corp status.

Dividends are paid out of retained earnings under any corporation. It's just that if the corporation is an S Corp, the dividends are not taxable. The capital structure of the corporation is not reported any differently.

Thanks for the kind words. The interrelationship between general accounting and taxes can be humbling.

[oceanlovin'ea]

Florida

Golden Rocket, I don't think that Florida has a minimum amount of capital stock in a business. They have 100 shares at $1.00 per share value.

I was particularly talking about small one owner/employee S corporations that incorporate their business which is usually a service business. They don't necessarily put a lot of money into the business to start with. These might have been sole proprietorships that incorporate their business.

They open a checking account with a couple of hundred dollars. Sometimes they have some equipment that goes into the business. They assign $100 to capital stock.

Theys start to operate their business and grow it from there.

So the first year they are in business, they might have gross receipts of 50,000 and expenses of $30,000 leaving profit of $20,000. But they have taken draws during the year in addition to their payroll of $24,000. That is possible due to mileage reimbursement increasing the deductions for the business.

This is the type of scenario I was talking about as far as the balance sheet and M-2 of the 1120S tax return. This would give them a negative balance on the M-2. Is that okay? Or how is that handled?

Linda F