S-Corp - to deduct TP equity interest

[LibertyJava]

Hi.

Scenario: sole shareholder (TP) takes out an equity line to provide financing for S-Corp (better financing rate, more money available). Loan agreement between the 2 stipulates that S-Corp assumes all responsibility for debt payments and has access to all loan disbursements (all debt is used for the business, none for personal use).

I believe the S-Corp would record interest expense, TP would show that on sched B as income and deduct on Schedule A.

Preference is to have S-Corp record it, and TP not to show income on B and not report expense on schedule A. (interest expense would flow through S-Corp profits to TP). Agree?

Is it a valid tax strategy for TP to start a sole proprietor business to obtain financing at reduced rates for the S-Corp. Then, instead of showing income on B and expense on A, both woudl be shown on Schedule C (netting out to $0). (The TP can elect to not treat securitized debt on schedule A if it can be shown the proceeds were used for business purposes). The tax advantage is the TP would be using the standard deduction instead of itemizing, and show the full interest expense on the first page of the 1040 as part of Schedule E profits, thus also reducing state taxes. Again, all loan proceeds can be traced to the business accounts or are directly paying business debts.

thoughts? suggestions?

[Davc]

Cute, but it won't fly.

[Mo Sheets]

Another Option...

What about having the S Corp take out the loan and if needed, have the sole owner guarantee the loan? It seems that it would solve the reporting issue. Since the sole owner was going to originally put the loan in his/her name anyway, they would be personally liable either way.

[Gary2]

What about having the S Corp take out the loan and if needed, have the sole owner guarantee the loan? It seems that it would solve the reporting issue. Since the sole owner was going to originally put the loan in his/her name anyway, they would be personally liable either way.

The obvious question here is whether the tax savings are better than the likely higher interest rate.

[erchess]

also the home equity

Note that to get the best deal on interest the guy had to get a home equity loan. A personal loan represents more risk to the lender because if the taxpayer can file for bankruptcy only the home equity loan allows the lender to take the house.

[S T]

Hmm,
Is it feasible, for the shareholder to deduct the Equity interest on Sched E page 2 - since it seems it is a S corp shareholder Loan to the S Corp. (I would hope he does not have a "mixed-loan" with personal and could clearly establish) Check from Equity Line directly deposited to S Corp.

S Corp records the loan - repays the Shareholder - Shareholder deducts the interest

I am probably overlooking something

Sandy

[Gary2]

Hmm,
Is it feasible, for the shareholder to deduct the Equity interest on Sched E page 2 - since it seems it is a S corp shareholder Loan to the S Corp. (I would hope he does not have a "mixed-loan" with personal and could clearly establish) Check from Equity Line directly deposited to S Corp.

S Corp records the loan - repays the Shareholder - Shareholder deducts the interest

I don't see how. There's no provision on Schedule E for taking deductions against S-Corp income, nor should be.

There's a home equity loan from the lender to the shareholder. There's a separate loan from the shareholder to the S-Corp. The shareholder accepts having the S-Corp pay the lender directly as payment on his loan to the S-Corp, but it's still interest income to the shareholder - 1099-INT income, not K-1 interest income.

[S T]

This was from another post, not TB

http://www.taxalmanac.org/index.php/Discussion:S_corp._shareholder_loan_funded_with_home_eqity_debt

Maybe we need some add'l info from the OP

Sandy

[Edsel]

Options

For a personal loan, the S corp cannot deduct the interest. Period. (Not true if the corporation makes the loan and the shareholder guarantees it).

If this is a personal loan the only avenues for deductibility would be:
a) Form 4952. I don't like this one for a number of reasons. It is an itemized deduction which is not as strong as a business deduction. Plus it destroys LTCG treatment in event of a disposition.
b) PUE (Partners' Unreimbursed Expenses). Charter can be structured such that the individual can claim the expense on the back of Schedule E even though not distributed through the K-1. (PUE is a misnomer because there may be no "partners", but it will still work for an S corp)

[Gary2]

This was from another post, not TB

http://www.taxalmanac.org/index.php/Discussion:S_corp._shareholder_loan_funded_with_home_eqity_debt

Good find.

That led me to reading through the Sch. E instructions and Pub. 535, and I stand corrected. There is a provision for deducting some qualifying interest expenses in Part II of Schedule E, but it's documented in Pub. 525, chapter 4, under Allocation of Interest, page 12, "How to Report." Essentially, add another line to the Partnership/S-Corp section, described as "interest expense - Name of entity", with the interest in either column f or h as appropriate.

That thread suggests that in order to do this, the loan to the S-Corp has to be characterized as acquisition debt or additional paid-in capital. Whether that can be done at this date, or how the S-Corp would book the repayments is well beyond me. So I can't comment on whether that posting is right, or applicable, or wise.

[Gary2]

For a personal loan, the S corp cannot deduct the interest. Period. (Not true if the corporation makes the loan and the shareholder guarantees it).

I'm not sure how you mean that. The way things stand as described in the base note, the shareholder took out a personal loan, not the S-Corp. The S-Corp took out a business loan from the shareholder (a common and legitimate thing to do). The only connection between the two loans is that the shareholder, as part of his loan agreement with the S-Corp, said that if the S-Corp sends its payments on the business loan to such-and-such account (i.e. for the home equity loan), then the shareholder will accept that as having made payment on the business loan. Normally it's a no-no for an S-Corp to make direct personal payments on behalf of a shareholder, but I'm not sure that would apply if it's clearly documented in the business loan papers between the shareholder and S-Corp.

b) PUE (Partners' Unreimbursed Expenses). Charter can be structured such that the individual can claim the expense on the back of Schedule E even though not distributed through the K-1. (PUE is a misnomer because there may be no "partners", but it will still work for an S corp)

In that link cited by Sandy, the last entry clearly says that S-Corp shareholders, unlike partners, are not allowed to take unreimbursed partners' expense. I take it you disagree. Any citations?

[Edsel]

Commonly Done

In that link cited by Sandy, the last entry clearly says that S-Corp shareholders, unlike partners, are not allowed to take unreimbursed partners' expense. I take it you disagree. Any citations?

No citations Gary, but I have seen many, many of these and had a couple clients of my own do this. A most typical example would be where the shareholder is paying interest on a facility being used by a corporation and not charging rent to the corp.

I hope Sandy's link is disallowing this based on the fact that the owners are shareholders and not partners.

I do know for a fact that at least two different software packages allow this for S corps...