OT: Treatment Of Distributions Over AAA

[geekgirldany]

I put this as OT because I know the tax consequences.

I wanted to ask how most of you all talk to your clients regarding the "overage" of distributions when AAA is dropped to zero.

I know the correct way(s) to treat this. You can either do a loan to shareholder (prefer not) or report on Schedule D of individual.

The problem I am running into with a few clients is when I discuss the situation they automatically want to put it to loan to shareholder. I have to say that I try not to allow LTS to go over $10,000 if possible. I do accrue interest.

I have started leaning towards not even explaining it to the client. I mean not go into so much detail. I feel like all they hear is "If you do this you will get back $this much, if you do it the other way you will get back this $much". But then again I feel like they need to know.

I've took on three new clients this year where a local accountant allowed the Loan To Shareholder to get over $100,000 if not more. I can't and won't do this.

So if any of you could provide some insight on how to discuss this with clients I would really appreciate it.

Dany

[Gretel]

I do not have any experience myself but know of a CPA who doesn't even mention this to the client and have him pay the taxes. I generally tend to reveal too much details to my clients and can see his point of focusing more on the big picture.

[geekgirldany]

I feel like I sometimes also maybe explain too much. So much that they don't understand what I am saying. I get the deer in the headlights look often when talking about distributions, retained earnings, and AAA. I think just the only thing they really understand is how much money they are getting back or how much they owe. Bottom line.

[JohnH]

I'm curious. What's your concern about shareholder loans, provided the loan is documented AND interest is being paid if the amount exceeds $10K?

[veritas]

A negative triple A account

is possible without negative tax consequences.

You have to look at the shareholder's outside basis.

[geekgirldany]

On the loan to shareholders my concern is what happens if or when the S-Corporation closes down... what happens to that loan to shareholder? Would it not be reclassified as a distribution in excess of basis and Capital Gain taxes paid?

On the AAA, distributions can't bring it into a negative amount. I know that there are other entries that can. In the case of my clients the inside and outside basis is the same because these are sole shareholders, new businesses.

[veritas]

assuming basis is exhausted

there may be no federal tax in any case. Long term gains to a point are taxed at O%.

Just a thought.

[BHoffman]

Hi Dany - I've found that Scorps need some bit of babysitting, so I check in on them quarterly to see what kind of trouble they are getting themselves into

That has helped a lot over the years, and gives me a chance to explain those harder things like shareholder basis over a few meetings throughout the year instead of all at once.

[geekgirldany]

Thanks Hoff. Most of my S-Corps I do meet with during or right before the end of the year. There are probably three or four that I don't see until tax time. I guess I need to make it a priority to touch base with them even if they think they don't need to.

Vert, that is true on the capital gains. Which saves them so much. But what happens most of the time is that they owe on the state. I have acquired several clients with Loan To Shareholders over $100,000 or more. I would like to get that cleared up for them in 09 and 10 since capital gains 0% will expire at the end of 2010.

I guess I just have to take a different approach in explaining. I am the tax professional here. So giving them such options might be to much. I don't give people options on claiming various deductions, expenses, filing status, etc. Either they are allowed or not. Really I should change my way of thinking.

I appreciate you all taking the time to post and talk this over with me. It was more like me blowing off steam I guess.... you guys know what it is like.

Thank you
DAny

[Black Bart]

I think you're right and

...The problem I am running into with a few clients is when I discuss the situation they automatically want to put it to loan to shareholder. I have to say that I try not to allow LTS to go over $10,000 if possible. I do accrue interest.

I have started leaning towards not even explaining it to the client. I mean not go into so much detail. I feel like all they hear is "If you do this you will get back $this much, if you do it the other way you will get back this $much". But then again I feel like they need to know.

I've took on three new clients this year where a local accountant allowed the Loan To Shareholder to get over $100,000 if not more. I can't and won't do this...

I don't think you're overly or unduly concerned. The thing is, nine times out of ten it's NOT a loan -- it's a distribution. They just wanted some money, took it out, and the only document related to this "loan" is a cancelled check. But...they don't care about any of that -- they just want you to "handle it."

...I feel like I sometimes also maybe explain too much. So much that they don't understand what I am saying. I get the deer in the headlights look often when talking about distributions, retained earnings, and AAA. I think just the only thing they really understand is how much money they are getting back or how much they owe. Bottom line.

I also tend to overexplain and get those same looks and I used to think "Well, they just don't understand," but the older I get the more it sinks in that it's not they don't understand, but that they just don't care and -- as you say -- the bottom line is their sole interest.

While I no longer have any S-corps, when I did this was always a problem that I was concerned with. And there is always a competitor around who'll tell them that it's "no problem." But regardless of that, I think you're right to go with your gut instinct on such things and don't do anything that makes you uncomfortable. Many (not all) clients will go along with you if you feel you're doing the right thing.

Hang in there babe!

[BHoffman]

Dany - I don't give them the option of recording it as a Loan to Shareholder. Unless the payment to the shareholder was specifically made as a loan that is definitely going to be repaid with interest, and that was the understanding at the time the shareholder received the money, it is in fact a distribution in excess of basis.

IMHO: It is what it is.

I think using the Loan to Shareholder just to avoid capital gains tax is borrowing trouble.....and it's pretty early this morning for a pun

Also, the shareholder is going to end up paying some sort of tax on that money one way or another. It seems to make sense to pay the lower capital gains rate now, rather than try to defer. Otherwise, the shareholder will end up paying ordinary income tax rates or even SE tax on a portion of it. Using the Loan to Shareholder account merely defers the tax bite, and does not negate it.

[JohnH]

This is a great discussion. It has prompted me to re-think a couple of client situations already. Dany, thanks for starting the subject and thanks to everyone who is responding & continuing to share their insights.

[Gretel]

After reading all of this I think the true problem is right at the beginning of a corporation when someone suggests that a distribution could be a loan and thereby taxes avoided. I mean, where would a guy off the street even know about such things if nobody ever explained them?

[BHoffman]

After reading all of this I think the true problem is right at the beginning of a corporation when someone suggests that a distribution could be a loan and thereby taxes avoided. I mean, where would a guy off the street even know about such things if nobody ever explained them?

Complete agree with Gretel. And, as I said, I think it's very important to make it clear that the tax is going to be due someday. It's not a way to avoid paying tax. It's just a way to avoid paying tax right now.

[JohnH]

It also works in reverse, in a slightly more convoluted fashion. I have a client who is still questioning why they are "paying tax" on a loan their S-Corp repaid to THEM last year.

This is a retail type business with no significant depreciation or other phantom items which alter the cash results in any meaningful way. They loaned the company money over several years to cover operating expenses and of course the resulting tax deductions flowed through to their tax return. THAT part of the transaction they understood.

Last year the corp earned a nice profit and they took a full loan repayment, telling me they were sure it wasn't taxable income to them. So when I tried to explain that although the loan repayment itself was not income to them, the S-corp had to get the money it used to repay them from somewhere. It came either from borrowings or from profits and since the net profit shows up on their personal tax return, they still wind up paying tax on the earnings. Net result is a wash when compared year-over-year, but somehow they're having trouble wrapping their minds around the second part of the explanation.