C-Corp Loan To SH

[geekgirldany]

(Title should be C-Corp Loan From Shareholder)

I have a new client, C-Corp, which had three shareholders. Father, Mother, Son. Father passed away in 2012, Mother 2013. Mother always handled the bookkeeping and dealing with CPA on taxes. Son has come to me to prepare the return this year. C-Corp been around since the 80s.

I've been working my way through the bookkeeping, kept on excel and quickbooks, and I have the P&L worked out and I am comfortable with it. Balance sheet is still not there.

2012 tax return had a loan from shareholder of over $120,000. Questioned Son, he isn't exactly sure where it came from but thinks that his father/mother might have loaned money to the business. While working on the return, I found reimbursement worksheets filled out where the shareholders (mostly mom) paid for various expenses personally for the business.... but they were never paid back. I have atleast three years showing this. I can not find any checks showing repayment. So my thinking is that the prior CPA took these amounts that the shareholders paid personally and added them to loan from shareholder but they were never included as expense.

So that leads me to having this large loan from shareholder. Is it possible that this could be written off as a cancellation of debt? Especially since mother and father have passed away. I really have no way of tracing back where the amount came from other than the above. If you take 30 years of expenses being paid by shareholders and never being paid back... that amount could be realistic.

If the debt is cancelled, then that would mean income to C-Corp, with a 1099-C filed to them correct?
That then brings me to this... there were amounts in the LFS that were never deducted as expenses... so some of it could not be included in COD but do not know how much.

I have a question on another expense but will post that separately. I am just trying to get this as clean as possible for the son to start taking things on the right direction.
I really feel like there is no need for a LFS to keep hanging out there but I also do not want a COD to cause problems with his parent's final tax returns.

Thank you for any help.

[Roland Slugg]

If the debt is cancelled, then that would mean income to the father and mother.

Huh???

In your post you referred to the $120k as a loan FROM the shareholders. If that is true, then if it is forgiven, it would result in income to the corporation, not the deceased parents.

If you have the corp's general ledger going all the way back, it should not be too difficult to see the shareholder advances. If the books are a mess, it might be time-consuming but still possible to reconstruct everything.

Consider retroactively reclassifying the loans as additional paid-in capital. That would increase the parents' basis in the shares, but since they are both deceased, it doesn't make any difference.

[geekgirldany]

Opps Roland.... I got that backwards. I will correct my original post.

Yes I mean COD to C-Corp not shareholders. I am so use to working with LTS not LFS. So I got that really messed up.

The mother did all the bookkeeping. The only thing ever recorded was Reimbursement worksheets that had receipts attached. I might could get back excel spreadsheets for prior years. But there is nothing on them about the Loan From Shareholder.

I will look at Paid In Capital... I had not thought of that. Just really want to get this off the books because looking at prior years the C-Corp would never get this paid off in a reasonable period of time.

[buzzardbreath]

One Benefit

One benefit of carrying a loan from the corp TO a shareholder: The loan can always absorb distributions without them being classified as dividends. I believe this to be a strong benefit and I would hate to lose this benefit simply because someone died.

I propose the following, and invite the likes of Roland Slugg or others to comment or tell me that death precludes the following treatment:

Set up loans payable to the beneficiaries which total the same value. This would not be the same as the capital accounts which could be revalued upon death - they would retain the same dollar value. Then if the C corp is going to continue to operate, distributions to the beneficiaries would reduce the loan accordingly, and they would escape treatment as dividends.

[TXEA]

From Your Post " So my thinking is that the prior CPA took these amounts that the shareholders paid personally and added them to loan from shareholder but they were never included as expense."

I am trying to understand why you are thinking the loans from the shareholders were never deducted as expenses. I think you mentioned the tax return shows a payable to the shareholders. So, assuming the balance sheet balances, then the logical offset to this amount would have been a debit to the expense accounts or equipment and machinery. Or, they could have loaned cash to the corporation that was used to pay expenses.

I would not assume the prior preparer did not properly account for the shareholder loans as it would be impossible for the balance sheet to balance if you just increased shareholder loans.......some other account has to change also.

As buzzardbreath pointed out, someone inherited the N/R from the corporation after mom and dad passed away. They should be the new recipients of the payments on the loan. The only caveat I would add to buzzard's comment is that there really needs to exist a loan document with stated interest and payment requirements and collateral to really document that this is a bona-fide loan especially since we are dealing with related parties. This will be needed to defend any argument that this was a contribution to capital (especially if the corp was undercapitalized - not sure how long the corp has been in business).

Finally, I would not discuss the issue of cancellation of the note at this time. Evaluate whether the corp has the capacity to repay the loan first.

[JohnH]

This is an interesting situation, and I agree with the admonition not to remove the loan from the books. This is especially true if the son inherited the common stock of the corporation and the note receivable owned by the parents as well. A promissory note can be drawn up bearing a reasonable interest rate, and payments made on the note.

I'm not even sure it matters whether the loan can ever be paid off. We are guessing at lots of things in the absence of information, but there are some tax planning possibilities here. Payments of interest on the loan are deductible by the corporation and taxable as interest income on the recipient's tax return. That's a given. Principal payments are not deductible, and therefore the income which generates the principal payments is taxed to the corporation. However, the note holder will pay no tax on the principal payments received. The other scenario is that the corp pays tax on its income, distributes that income to the shareholder as dividends, and the shareholder pays tax on the dividends. Given those two scenarios, receiving the principal payments is preferable.

This all assumes that the son who inherited the business is also the only shareholder and the only holder of the note. If there are other heirs, then this may not be so good. But food for thought under the right circumstances. It also assumes the books are in balance and that the loan is legitimate in the first place. I'd probably look back 2-3 years just to satisfy myself that things were handled correctly during that time frame, then go with the info I was given.

[Zee]

From Your Post " So my thinking is that the prior CPA took these amounts that the shareholders paid personally and added them to loan from shareholder but they were never included as expense."

I am trying to understand why you are thinking the loans from the shareholders were never deducted as expenses. I think you mentioned the tax return shows a payable to the shareholders. So, assuming the balance sheet balances, then the logical offset to this amount would have been a debit to the expense accounts or equipment and machinery. Or, they could have loaned cash to the corporation that was used to pay expenses.

I would not assume the prior preparer did not properly account for the shareholder loans as it would be impossible for the balance sheet to balance if you just increased shareholder loans.......some other account has to change also.

As buzzardbreath pointed out, someone inherited the N/R from the corporation after mom and dad passed away. They should be the new recipients of the payments on the loan. The only caveat I would add to buzzard's comment is that there really needs to exist a loan document with stated interest and payment requirements and collateral to really document that this is a bona-fide loan especially since we are dealing with related parties. This will be needed to defend any argument that this was a contribution to capital (especially if the corp was undercapitalized - not sure how long the corp has been in business).

Finally, I would not discuss the issue of cancellation of the note at this time. Evaluate whether the corp has the capacity to repay the loan first.

I'm in agreement with this response, if a loan was recorded it would appear the expenses were deducted. If there is no loan agreement and no interest has been paid or recorded, it most likely represents a contribution of capital.

[geekgirldany]

Thank you all for responding. I agree that it should be left a loan from shareholder... if I can get a good idea on the increases each year. Hesitant on repayment of the loan without knowing something. As stated it could be reclassified as paid in capital. Son really doesn't know at all. He said all three would put money into the business but I can not find deposits into the bank account from any in the past two years. I've asked for more prior year returns to try and figure this out.

Posters are correct that if there is an LFS there would be a corresponding amount for an expense or some other bill being paid. I do know that one SH was paying on a company car personally. But that still would not add up to an increase of $20,000 on year and $7,000 on the next.

I am uneasy on the balance sheet.... it balances but I don't know something does not seem right. CPA prepared it so it should be correct. Hopefully these additional returns will help.

[Burke]

Is there a problem with simply calling the prior CPA to clarify?