S-Corp Investment

[geekgirldany]

I have a new S-Corp client. Started the business in 2010. He received a loan from a investor of $2,500 a month. The loan will have to be paid back starting late 2012.

My confusion is the client used this loan to pay himself around $29,000. He did not pay himself a "payroll" just took the money out of the corporation. The company made just enough to cover expenses and has a loss of about $2,000.

So I am unsure what to do with the $29,000 he took out as distributions. He has no shareholder basis in the company. So all the $29,000 would be taxed as capital gains. I also could insist that it be reclassified as payroll and him pay taxes on it. Another option would be Loan to Shareholder with accrued interest.... don't really want to do that.

In 2010, it appears that the money he took was classified as distributions as it is coded against retained earnings in the bookkeeping.

Thing is I am not doing his personal return. The wife is doing it on TT. So I am not sure if I say the excess distributions would even be put on the personal return.

I guess what is messing me up is him receiving the money from this investor and then just using most of it to pay himself.

Would appreciate any feedback on this.

[Koss]

Distributions

Loan to shareholder might work, but I agree that gets complicated.

If he's running the business, he really needs to have a salary. It can't be all shareholder distributions. Some of it could be treated as a distributions, but not all of it. The question is what is reasonable compensation for the work that he did.

The IRS loves to audit this kind of thing. By allocating the entire amount to shareholder distributions, it avoids FICA, and that just won't fly. If he's working for the company, then some of it has to be payroll.

BMK

[ChEAr$]

I have a new S-Corp client. Started the business in 2010. He received a loan from a investor of $2,500 a month. The loan will have to be paid back starting late 2012.

First things first. You say "he" received a loan.... What means "he"? He, the shareholder? Or did the corporation itself borrow the money? Look to corporate resolution by board of directors for authorization for corporate borrowing Then get a copy of the loan agreement to be sure.

IF... if shareholder himself borrowed the money and received the funds from investor in his name, doesn't matter what he did ithe money, maybe endorsed the check over to the corporation maybe? If so, he is one who lent money to the corporation.

Facts please.

[Gary2]

My confusion is the client used this loan to pay himself around $29,000. He did not pay himself a "payroll" just took the money out of the corporation. The company made just enough to cover expenses and has a loss of about $2,000.

Does the loss include paying the $29,000?

[geekgirldany]

Well the checks from the investor which is another Corporation went directly into the S-Corp bank account. So they were written to the S-Corp.... unless the bank deposited them with the shareholder's name on it. There is no documentation within the S-Corporation but I am sure I could ask for the contract between the investor and the S-Corp.

Gary, the $2,000 loss does not include the $29,000. He said a friend did the 2010 return and is trying to get a copy. From looking at the books it appears the 2010 payments to shareholders, which was about $10,000, was written off as distributions as there is a journal entry against Retained Earnings.

From my understanding I believe my client is a underneath the larger corporation. I suppose like a franchise deal. He is representing them in georgia. They invested money for two years to help him get started. Looking at the books he was able to bring in income enough to cover start up expenses. So he took the money they were investing for himself to live on.

[Koss]

Distributions

Gary2 and ChEAr$ both raised some very good questions that had not occurred to me.

Based on your response, it does sound like it is a loan to the corporation.

I don't think it should be characterized as a distribution. When you properly account for that money, the company actually had a net loss of $31,000 for the year--not $2,000.

I stand by my original assertion that a shareholder who is actively working in the business must take reasonable compensation, in form of wages or salary, for the work performed.

BMK