Investment in C Corp

[MelanieCPA]

Client works for Co X, and receives a W-2. Co X was a C Corp in 2006 and converted to an S Corp in 2007. Client is buying into Co X. Was given a loan from the owners to buy 5% stake at discounted price and pay over 5 years at 4%interest. A small interest payment was made in 2006.
How should this interest payment be treated? Does it go on 4952 as Investment Int Exp?

[BOB W]

Interest...

This type of interest is not deductible anywhere, but it can be added to his outside basis of the stock purchased. IRS states that financed stock aquistition for an active shareholder/employee is not available as investment interest expense.

[OldJack]

If the employee/shareholder gives his residence as security on the loan it can be deducted as mortgage interest. Also, I believe interest paid on a loan to purchase small business stock is deductible as business interest expense. In the case of a S-corp that would be on form 1040 Sch-E, page 2 on the next line after the S-corp income is reported. I can't find the citation in my big tax book.

[MelanieCPA]

One more thing...

Thanks OldJack. I found the same info. What about 2006 when the co was still a C Corp??

[BOB W]

4952

Older versions of 4952 instructions use to say the interest was not deductible when financing stock ownership in a corp when the shareholder actively participates in the business. The 2006 4952 instructions hints at it but does not say it any more.

I had an audit 5 years ago on just such a situstion where I took the investment interest expense and it was disallowed. So be aware>>>>>>>>>

ADDED>>>>_____ Verify via loan documents, etc., that interest expense is for monies borrowed to buy investments that produce interest, dividends, royalties or annuities. It is not interest expense to purchase a business or rental property. See § 163(d) and § 469(e)(1). Investment interest expense is NOT interest to purchase an "investment" in a partnership or S Corporation. If entity is a rental, interest goes on Form 8582 line 1b or 3b. If the taxpayer does not materially participate (work on a regular basis-IRC § 469(h), Reg. § 1.469-5T(a)) in the entity, interest expense goes on Form 8582 line 3b. If the taxpayer materially participates in business, interest is deductible on back of Schedule E.>>>>>>>>>>>


They must of changed this with in the last few years............