Tax/Accounting Question

[JG EA]

Loan was made from S Corporation funds to an individual (friend of the only shareholder) in 2005.

Loan was not repaid

Friend signed over his interest in a house to repay the loan in 2006.

Shareholder took possession of the house under his name (not in the Corps name).

Shareholder took out a mortgage to pay the balance owed on the house.

My thought was to distribute the loan to the shareholder on the date he took possesion of the house. Does this make sense?

[Snaggletooth]

A little earlier

I think you said it in your own words JG, "Friend signed over his interest in a house to repay the loan in 2006." By signing over his interest to the stockholder (not the corporation), this presumably terminated his liability to the corporation. I believe at that point the stockholder received a distribution.

In the above paragraph, the word "presumably" might torpedo the above interpretation. For example, what if the monetary equity in the house was not sufficient to satisfy the loan? I don't have a lot of confidence in my answer, and would like to hear from others.

Regards, Snag

[OldJack]

mortgage

Well... you have to take into account the intent of the shareholder. The shareholder has the option to take the loan as a distribution or to assume the loan and owe the S-corp for the full amount still owed the business by signing a new note. If the shareholder wants to assume the loan it should be setup as a second mortgage loan so that the shareholder makes deductible mortgage interest payments for his 1040 Sch-A. In such mortgage case the S-corp would issue a 1098 at the end of each year to report the mortgage interest paid.

[JG EA]

Thanks

Thanks for this. I will ask the Shareholder which option he wants to take. (I mean ask the Pres of the Corp what his negotiations with the Shareholder have decided on!)

Appreciate it,
JG

[Zee]

I'm not sure I understand. Was this loan related in any way to the business of the S-Corporation? If not, it would seem to me the shareholder took a distribution at the time the loan was made and the loan should be recorded as a personal loan not on the books of the S-Corporation.

[JG EA]

Not really related

The loan was made from the S Corp just as a way to use the money. (And because the friend needed the money). The idea was to make some interest on the money loaned out. It was supposed to be a sure thing that the money would be repaid quickly. But no other business interest was involved.

That is a good point though, that it was personal all along. But I didn't think of that in 2005, and even when it was seen that the loan would not be repaid, some effort was made to buy the house in the name of the Corp, but the idea was abandoned before the settlement.

[Snaggletooth]

Kinda Gray

I hear what Zee is saying about personal intent from the beginning, but this is somewhat grey and not black/white.

A corporation is not supposed to engage in activities outside their business purpose, and a loan to the friend of a stockholder is very suspect. However there was a profit intent as I perceive this was an interest-bearing loan. Corporations, however, invest in marketable securities quite frequently -- such things as CDs, even stocks/bonds, and these things are carried without question on the books as Marketable Securities.

I would give the client benefit of the doubt on this one.

I've lived quite a career watching "sure things" from debtors. Most often these are in fact friends, but are people that banks and loan companies have given up on...these institutions wisely turning down profits because they won't outweight the risk. I don't know how many clients have co-signed loans for family and friends that were already not credit-worthy.

[Zee]

I hear what Zee is saying about personal intent from the beginning, but this is somewhat grey and not black/white.

A corporation is not supposed to engage in activities outside their business purpose, and a loan to the friend of a stockholder is very suspect. However there was a profit intent as I perceive this was an interest-bearing loan. Corporations, however, invest in marketable securities quite frequently -- such things as CDs, even stocks/bonds, and these things are carried without question on the books as Marketable Securities.

I would give the client benefit of the doubt on this one.

I've lived quite a career watching "sure things" from debtors. Most often these are in fact friends, but are people that banks and loan companies have given up on...these institutions wisely turning down profits because they won't outweight the risk. I don't know how many clients have co-signed loans for family and friends that were already credit-worthy.

What if this debt had become completely worthless? I'd have a hard time treating this as a business write-off. However...what's done is done. I'd just get it off the S-Corp books at this point.

[OldJack]

That is a good point though, that it was personal all along. But I didn't think of that in 2005, and even when it was seen that the loan would not be repaid, some effort was made to buy the house in the name of the Corp, but the idea was abandoned before the settlement.

A C-corp or S-corp is a separate legal entity from shareholders and can invest in any legal investment. A corporation can invest in its shareholders residence (or friends) by way of a mortgage loan investment and as long as it is done at arms-length there is no taxable personal benefit or taxable transaction involved. If the investment loan is not documented properly or not treated as an arms-length debt would be, then you may have a taxable benefit charged to the shareholder.

I have clients that their corporation has a mortgage (in writing) on their summer home and they pay monthly mortgage payments (by way of payroll withholding) and the corporation issues mortgage 1098 form for the mortgage interest each year. The shareholder takes a reasonable salary so there is no issue of the loan being reclassified as salary.

[JG EA]

Another really good point

I am actually very happy not to deal with a bad debt issue. I think my inclination would be to transfer it to the personal return on a D. Just glad it didn't happen.

Thanks also Snag and Jack - you always answer accounting questions and it is appreciated.

In answer to your last post OJ, it is obvious that there is much I haven't thought through.

[OldJack]

I think my inclination would be to transfer it to the personal return on a D.

There is no transaction required for a 1040 Sch-D unless you just want to make the shareholder pay taxes. The loan was assumed by the shareholder when he took payment from the friend. Before you make this taxpayer pay taxes you should ask him if he would prefer to owe the company.