S-Corp pays back personal loan to business made by sole Shareholder

[TaxTrooper]

When a single member SH contributes funds from a personal loan, and the S-Corp pays both the principal and interest to the bank:
Do both P & I reduce basis to the SH or does the interest portion paid by the S-Corp get recognized as income to the SH?
If the latter, can this be done on the 1120S or does a 1099-INT need to be issued from the S-Corp to the owner for the interest portion?
(In essence, the S-Corp is paying the interest on the personal loan, while receiving benefits of the loan proceeds for legitimate busn. expense)

[TaxGuyBill]

Did the shareholder "contribute" to the corporation (make a capital contribution)? Or did the shareholder LOAN the corporation money (and is there a loan document between the shareholder and corporation)?

[terryats]

Need more detail, as TaxGuyBill asked. Here is a good article from Tax Adviser on the subject:

https://www.thetaxadviser.com/issues/2017/dec/structuring-loans-s-corp-shareholder-basis-planning-opportunities.html

[TaxTrooper]

The SH made a contribution and loan doc is between the bank and Shareholder. The article is helpful - thanks for that and am using it for reference:

Debt basis has 2 requirements: 1) must be from Shareholder to S-Corp and 2) must be bona-fide. "Regs. Sec. 1.166-1(c) defines a bona fide debt as arising from a debtor-creditor relationship based on a valid and enforceable obligation to pay a fixed or determinable amount of money . . . The shareholder must have a real expectation of repayment and intent to enforce collection efforts against the S corporation in the event of a default on the loan."

The article continues: "The definition of bona fide debt is met without a doubt when the source of the funds is an unrelated third party such as a bank. If the shareholder borrows funds from a bank and lends the cash to the S corporation, the bank will hold the shareholder to repayment terms. The conclusion is less certain when the loan is made between related parties or between the shareholder and entities with common ownership. In these situations, it is important to document the intent of the parties by characterizing the transaction as a loan in the corporate resolutions and accounting records

Given the above and considering this case - the loan was made from SH to Corp (there is a bona-fide debt from SH to Bank) I can interpret this satisfying both 1) & 2) yet would have S-Corp and Shareholder draft simple agreement between the two to characterize basis as debt.

Alternate Scenario					Basis	Remarks
Shareholder	Borrows	Bank	$ 3,500		no effect Basis until	Debt Basis is created WITH
Shareholder	Loans	S-Corp	$ 3,500		Increase in Basis	an enforceable loan agreement
S-Corp	Repays	Shareholder	$ 3,500		Decrease in Basis	made between SH & S-Corp

Otherwise, as is currently: this remains Equity Basis thru Cap Contribution and because S-Corp is 'giving back' so to speak the contribution, it decreases the Equity Basis.

What occurred					Basis	Remarks
Shareholder	Borrows	Bank	$ 3,500		no effect Basis until	Equity Basis Cap Contribn WHEN
Shareholder	Loans	S-Corp	$ 3,500		Increase in Basis	used to pay documented busn exp
S-Corp	Repays	Bank	$ 3,500		Decrease in Basis	S-Corp pays loan (Guar. By SH) to Lender

I go to this length, because not only the principal of the note is being paid back ==> there is the matter of the interest. Because the S-Corp is paying the interest (above what was given as Principal $3,500) then what is the character of the interest payments? Are these now Income to the Shareholder, does a 1099-INT need to be issued, or is there a simpler & legit. manner to report on the 1120S the amount of interest paid (under $300).


citation: https://www.thetaxadviser.com/issues...rtunities.html

[TaxGuyBill]

Otherwise, as is currently: this remains Equity Basis thru Cap Contribution and because S-Corp is 'giving back' so to speak the contribution, it decreases the Equity Basis.

As it is currently, the corporation isn't paying any interest because the corporation doesn't have a loan with the shareholder.

[terryats]

Being that you borrowed money for investment, if you itemize you may be able take the interest on schedule A on your 1040. As Bill said the Scorp has no loan.

[TaxTrooper]

Are the interest portions of the payments that are being paid by the S-Corp to the Bank on the Shareholder's behalf, then characterized as distributions? I can see the principal portion paid being a return of capital, yet the interest expense is over and above the $3,500 that was given to the S-Corp.

The interest paid was booked as interest expense; so if it is legally not a loan, is this still a legit business expense or something different?

(--- also, there's no opportunity for itemization on 1040)

[TaxGuyBill]

If the corporation does not have a loan, all payments the corporation make for this scenario are either (a) Wages and/or (b) Distributions to the shareholder. The shareholder is merely directing these Wages or Distributions to pay off a personal debt.

I'm not aware of such an option, but perhaps the bank loan could be considered as 'constructively' being the corporation's debt. But offhand, I don't think that is allowed.

Maybe it is allowable to retroactively set up a loan agreement between the corporation and shareholder to create a loan from the shareholder to the corporation because that does SEEM to be the intent. But unless/until that is done, as I said before, all of these payments are Wages or Distributions to the shareholder.

[TaxTrooper]

I do understand your logic and hear your caution in each option. Most of all, I appreciate your feedback and patience in following along and responding to my questions on this topic - thank you!