Depreciation between Sch C & S corp

[S T]

Another Question on S Corps

Is there a difference between classifying APIC and loans when it comes to At Risk for form 6198. Particularly if the S Corp is showing losses in the first 2-3 years as opposed to showing profit?

Sandy

[Bees Knees]

Stock basis and loan basis will both increase at-risk basis. The only problem with loan basis is the requirement to track it separate from stock basis, and the possibility that as loans are repaid, you have to recapture losses deducted in prior years as a result of loan basis.

Personally, I think that is much-a-do-about nothing (is that the right phrase?). OK, so the corporation repays the loan, plus interest. The only reason the corporation would have the money to repay a shareholder loan is because it made money. Therefore, even though the loan basis is being reduced in the year the loan is repaid, stock basis is being increased by the corporation profits, and therefore the risk of having to recapture prior year losses deducted against the loan basis is minimized.

I don’t believe the other issue about imputing interest is such a big deal either. The code allows you to lend up to $10,000 to your corporation interest free [section 7872(c)(3)]. Plus, charging interest on the loan is a good way to eventually pull profits out without having to pay FICA tax on wages.

The problem I have with APIC is the stock redemption rule. If you are a 100% shareholder of a corporation, and try to redeem 50% of the capital in your corporation, what is the percentage of stock owned by you after the redemption? You are still a 100% shareholder. Therefore, under Section 302, the IRS could say it was not a substantially disproportionate redemption of stock under Reg. Section 1.302-3 and reclassify it as a dividend distribution. That might not be a problem for a corporation that has always been an S corporation, but if the corporation was ever a C corporation, or somehow acquired C corporation earnings and profits, that means your distribution is a dividend distribution and not a stock redemption. The paid in capital is essentially tied up inside the corporation and can only come out as a last resort.

You also confuse the issue with additional paid in capital when additional shares of stock are issued. Again, not a big deal if it is a single shareholder corporation. But when there are multiple owners, you have to be careful not to create a second class of stock and terminate your S status. For example, Armando and I are 50/50 shareholders, each receiving 50% of the profits. The corporation is low on cash, so I kick in $1,000 and call it paid in capital rather than a short term loan. If I am still only entitled to 50% of the profits after my APIC, we just terminated our S election by creating a second class of stock.

In my opinion, if you need to put additional money into the corporation for whatever reason after its formation, it should be a loan, documented by a note with a stated interest rate.

[S T]

Very helpful

Bees,
Thanks so much for the approach and the issues/transactions to be wary of. It truly assists in analyzing a S corp transactions when the information is received or if we are monitoring the accounting.

Seems like we have to analyze on a case by case basis on S corps to which direction of APIC or Loans are better. Unfortunately none of us have that "Magic Cyrstal Ball" to see where the S corp is headed in the first couple years of business.

Sandy