Loan and S Corp

[S T]

Husband and Wife purchased a business that is an S Corp. The purchase is on an installment note that they pay from personal funds.

Is this deductible as Investment Interest?

Sandy

[Gretel]

Sandy, if they bought the stocks of the company, I am pretty sure it's investment interest. If they just bought the assets, I don't know.

[theresa d]

schedule e

interest paid to acquire an interest in an s corp is deducted on a seperate line on schedule e. indicate business name and id # and put business interest. it's explained in 2004 quickfinder small business pg D-4. it also in an IRS publication 535 (i have the 2004 publication handy page E-6)

[JON]

Asset vs stock purchase

If they purchased the assets the note is a company note, if they purchased stock with the note the above treatment is correct....

[Matt Sova]

Assets or stock?

If the assets were purchased they formed the interest would be deducted at the S-Corp level (if they formed a new S-Corp). Say they bought the assets with the following:

Equipment 50,000
Goodwill 100,000

They would debit those accounts on the corporate books and credit L/P ABC Corp 150,000. Their corp would make the payments to ABC corp and deduct the interest expense.

[Gretel]

Matt, maybe you have a good solution for my dilemma. I hope you don't mind Sandy.

You know you difficult financing is and sometimes businesses and their owners have to come up with creative things, just to keep the dough rolling not to evade taxes.

So, a client of mine has to put some more money in S-Corp. to show a better net worth until some of the projects are finished and then take care of the problem themselves. So, shareholder loan is out of the question, wouldn't do anything to net worth. Additional paid in capital is out of the question since he wants to get the money back before he dissolves the corp. So for now it's just a contribution to be offset by some distributions.

The thing is he had to take out a note to make this contribution. Investment Interest?

[BOB W]

I've been through....

.... this with the IRS and Investment Interest is non-deductible when you are purchasing a business in which you participate in the business. The interest is counted towards "outside basis" for use at a later date.

Passive investment interest is allowed as investment interest expense subject to investment income. But personal interest expense related to an investment that you materially participate in is not currently deductible.

[BOB W]

If you look at.....

.... Pub 550 page 32 3rd column heading "Investment Property" and read the last sentence of the first paragraph. Basically it says, a business in which you participate is not investment property.

Investment property must be passive to have note interest deductible as investment interest.

[BOB W]

What's wrong,

nobody believes me???????

[Gretel]

Thanks Bob, for pointing this out. Read the Pub and agree. I wasn't aware of the material participation rule.

However, my client runs a second S-Corp. and does little work in the S-Corp. I was referring to. So, coming back to my question if interest paid for a contribution which is not paid in capital counts as investment interest.

The Pub. doesn't clearly say, only if you buy stock, so I assume it's then deductible?

[BOB W]

Not sure.........

......... what you are saying. Your client borrowed money to loan to his corporation and he wants to deduct the personal interest as investment interest. ??? Is this correct???

A loan is not the same as investment. Besides, doesn't the corporation have to pay interest to the shareholder for the loan???

[Gretel]

Bob, you just woke me up.

No it can not be a loan because of net-worth problem explained earlier. But I guess it is kind of a loan just not reported as one since an investment is more of a permanent nature. Of course, no interest deduction in this case.

Thanks again.

[BOB W]

Gee I ...........

.............. wish someone would wake me up, I getting tired already and there is too many weeks to go...............

[S T]

Stock Purchase

T/p purchased S Corp Stock,to acquire the ownership of business. Tthe note is held by the Seller (as an individual, not the S Corp). T/P materially participates in the business. Is the interest on the note deductible for the t/p as shareholder, and reported Part !!, Sched E of form 1040.

Are there any limitations of interest deduction to watch for?

Thanks

Sandy