Negative S-Corp AAA

[Unregistered]

We own an s-corporation and generally take almost all of the earnings out during the year, only leaving enough in to keep the business running and handle any contingincies that may arise. At the end of 2005 we decided to finance a ~$100,000 piece of equipment and we intend to section 179 a significant portion of it in order to get our income down to a level where we can contribute to Roth IRAs this year. We have the income necessary to take the deduction but we don't have enough paid-in capital and retained earnings to absord the resulting reduction in income. Before acquiring the asset we had a $30,000 stock basis and about five thousand dollars in the AAA acount. However, even though we will show a profit after taking the secion 179 expense our equity will be about -$40,000 since we financed the equipment. Is there any reasonable way around showing the $40,000 as capital gains on our personal tax return? I would like to classify the excess as a short-term receivable or possibly as a long-term note between us and the business but I would hate to have to pay taxable interest from us to the business. Any creative ideas here? Thanks.

Matt

[OldJack]

Maybe I don't understand everything. The AAA account is a running balance of retained income and losses. The AAA account can have a negative balance if the S-corp have more losses than profits but that does not result in capital gain. Your only concern is if you have received "distributions" in excess of your basis. A section 179 deduction is not a distribution but a part of the loss but your loss may not be deducted if you don't have basis. True the losses reduce your basis but if you have not taken a "distribution" you do not have a capital gain. Maybe its time to take more salary instead of distributions.

[Joe Btfsplk]

Negative AAA balance

The AAA may have a negative balance. However DISTRIBUTIONS cannot cause AAA to go below zero.
Future earnings can make the AAA positive ONLY after the negative balance has been restored.
See page 19-9 of the Tax Book.

[OldJack]

I doubt that you have a $40,000 negative AAA account as section 179 cannot be used to create a S-corp taxable loss. Section 179 deduction is limited to S-corp taxable income with any balance claimed carried forward to the next S-corp tax year for deduction. I don't understand your statement that you will have a S-corp profit after the section 179 and then have a negative AAA account. I expect that you have an accounting problem rather than a tax problem.

[Unregistered]

I doubt that you have a $40,000 negative AAA account as section 179 cannot be used to create a S-corp taxable loss. Section 179 deduction is limited to S-corp taxable income with any balance claimed carried forward to the next S-corp tax year for deduction. I don't understand your statement that you will have a S-corp profit after the section 179 and then have a negative AAA account. I expect that you have an accounting problem rather than a tax problem.

I really don't think it is an accounting problem. We started the year with 30,000 in capial stock and 4,401.02 in AAA. Up until the very end of the year our income was ~165,000 including depreciation and all other expenses but before purchasing the equipment. During the year we paid out 150,000 in dividends so our year end AAA acount excluding the section 179 deduction would be around 20,000. However, at the very end of the year we financed the machine and now I would like to section 179 about 90,000 of it, hence our AAA acount would drop to around -70,000 and total equity including capital stock would be -40,000. Essentially what happened (assuming we take the section 179) is that we took a loan to pay a distributions above our earnings even though the loan was technically for the equipment and all of our distribution were paid out before we ever took the loan.

So I guess the question is since we actually did pay out the dividends before purchasing the machine and we had positive AAA after all dividends were paid out can we have a negative balance in the AAA acount due to the section 179 deduction or will we need to account for it differently on our tax returns? And if we need to account for it in another way is there a way to account for it that would keep us from having to pay tax at a personal level? Thanks.

Matt

[JON]

Loans made to stockholders

You can have a negative AAA. The book AAA does not always match the individual basis by the stockholder. Basis should always be done at the stockholder level. If we assume books and stockholders' basis are the same and your description is accurate you have a taxable event to the stockholders. You have a return of capital to the extent of previous basis and paid in for stock and capital gain for the rest.

Alterntives include not 179ing all or just a part or reclassifing distributions as loans to stockholders with interest deemed paid. Waiting for the UTI to accumulate in a future period.

[Matt Sova]

Negative AAA

Here is how you get around your problem.

4401 AAA 1/1/05
165000 Income prior to 179
(90000) Section 179
_______
79,401 AAA prior to Distributions
(75,000) Distribution
_______
4401 AAA 12/31/05

The other 75000 taken out reclassify to Officer Loan Receivable. Remove it to the AAA account in 2006 against that year's earnings. Write a check (or checks) to the corporation for the 75k and write distribution checks to the owner(s) for the same amount.

Matt

[Unregistered]

Here is how you get around your problem.

4401 AAA 1/1/05
165000 Income prior to 179
(90000) Section 179
_______
79,401 AAA prior to Distributions
(75,000) Distribution
_______
4401 AAA 12/31/05

The other 75000 taken out reclassify to Officer Loan Receivable. Remove it to the AAA account in 2006 against that year's earnings. Write a check (or checks) to the corporation for the 75k and write distribution checks to the owner(s) for the same amount.

Matt

So, even if I need to create a note to ourselves from the business I can turn around immediately next year and essentially reclassify it as dividends against future earnings for that year? I would therefore pay very little interest to the business and not have to worry about reducing the equity accounts below zero? That sounds like a plan to me. I guess my confusion and concern in this matter has been how the IRS views loans to shareholders that exceed their total equity in the business. They have a line on the tax return specifically for it so they are obviously interested in that figure. I guess if I can support it with a note with a market interest rate it should be ok since it would then be an arms-length business transaction. I will then pay it back early in 2006 and issue an equal amount dividend against earnings as Matt Sova recommended. Unless someone can show me that that approach is significantly flawed I think that is the route I'll take. Thanks.

Matt

[BOB W]

Flawed.....

... for sure. But I use it on occasion myself. I think they call it an audit lottery.

[OldJack]

... flawed for sure. But I use it on occasion myself. I think they call it an audit lottery.

I agree with Bob W.. you have a very weak case on audit so the paperwork must be complete.

[Unregistered]

But a market loan to a shareholder is legitimate, right? So as long as I have the note from us to the corp. and I accrue and report interest it seems that I should be ok. I worked at a CPA office for a while and we did this (although without a note and without accruing interest) for clients on occassion but it was always in small amounts, usually just a few thousand dollars. I just don't want to end up doing this, then get audited and have it disallowed and have to come up with $30,000 to pay the tax plus interest and penalties. However if there is a good chance of it passing an audit I will do it as long as it makes financial sense. (ie. being able to contribute to our Roth IRAs will justify the interest we end up paying taxes on) We should be able to pay the loan off quickly so the interest amount should not be too much. So if I cross the Ts and dot the Is would it most likely be accepted in an IRS audit? Thanks for the input and sorry about my relentless pursuit of this topic.

Matt

[Matt Sova]

Note

If you have a note in place you are fine. Pay a market rate of interest to further solidify your case.

Matt