Business Interest

[DaveinTexas]

A client wants to purchase his father's S Corporation for $500,000. He will be obtaining a small business loan. He will become the sole shareholder in the corporation upon the purchase. Can he deduct the interest for the loan on Sch. C with no gross income reported on the Sch. C?

I know that you can deduct business interest, but he is not self employed and the interest is not an expense of the corporation.

Let's also assume he does not want to loan the money back to his own corporation, receive a basis increase, and then merge with his father's corporation.

TIA. I think I'll go back to bed now.

[erchess]

OK I am Confused

What does your client intend to do with the S-Corp? As near as I can figure he could either operate it as a going concern or dissolve it and use the assets in some way. If the latter however, why not just buy the assets from the S Corp and let Dad dissolve it? Also, if your client is not going to either operate the S Corp or use its assets in another business he can't deduct the interest imho AND the SBA will have a problem with his getting a loan from them to finance the purchase. If he is going to use the assets in another business, perhaps the interest would be an expense of that business. If he is going to use the assets in conjunction with his work as an employee the SBA may have a problem with his borrowing from them but I would expect the interest to perhaps be deductible as an employee business expense.

[les grans]

Does the S corporation comprise an active business and will the [new] shareholder materially participate in that business? If so, the interest he pays on the debt incurred with the purchase of the stock would be deductible as business interest on the shareholder's Schedule E.
You want to read IRS Notice 89-35 [maybe that's not the right cite; I've got CRS today.] A creative Google search will find it or at least several references to it...

[DaveinTexas]

The son will operate the business

and materially participate in the business just as his father did.

The interest on the loan does stem from the purchase of the company stock, so the interest is then deductible on page 2 of the E under Non Passive Loss (h)?

That sounds correct; that site notice was right on the money.

Thanks a lot.

[JohnH]

Would anything in this scenario change if the father financed the purchase of the stock in the corp rather than the son arranging financing through a third party, with the interest being paid directly to the father?

[les grans]

I think if the father and son keep the interest rate above the AFRs and avoid imputed interest there's no complications.

And/or maybe the father and son could find a better [shared, overall] income tax result if they considered a sale of the corporation's assets rather than its stock. Father might pay some tax at ordinary rate, but son could end up with a whopping amortizable intangible. Depends on what the assets [book and non-book] of the S corp are. ...or could be.

[JohnH]

Then to add one more level of complexity, what happens if the payments to the father are made by the S-corp on behalf of the son? How would this be treated by both the son and the S-corp?

[les grans]

The payment by the corporation for the son/shareholder is going to be either a deemed salary or a deemed distribution.
And I'll bet the son would prefer *not* to pay payroll taxes on this amount.... Oh yeah!!

[Gretel]

Digging

I am digging to find an answer to a question that keeps confusing me.

My client (A) is getting a loan from his father (B), who in turn gets this loan from a bank to purchase assets of S-Corp. Assuming that FM interest rates are used and loan instruments created, I need to find out about the interest deduction on the 1040's for A & B.

Since A is not purchasing stock with this money but loaning it to his S-Corp, I think there is not interest deduction just reporting of interest income.

Then when A pays B is just a personal transaction, right?

Is there any way to structure this, so A or B would have deductible interest?

Client needs to know how to set up loan (who is loaning whom) and if to deposit into his account or biz account.

[Maribeth]

I am digging to find an answer to a question that keeps confusing me.

My client (A) is getting a loan from his father (B), who in turn gets this loan from a bank to purchase assets of S-Corp. Assuming that FM interest rates are used and loan instruments created, I need to find out about the interest deduction on the 1040's for A & B.

Since A is not purchasing stock with this money but loaning it to his S-Corp, I think there is not interest deduction just reporting of interest income.

Then when A pays B is just a personal transaction, right?

Is there any way to structure this, so A or B would have deductible interest?

Client needs to know how to set up loan (who is loaning whom) and if to deposit into his account or biz account.

Facts: A gets loan from B and then loans same to Scorp.
B get loan from Bank and loans same to A

A has interest income from Scorp and Scorp has interest deduction. A also has investment interest deduction.

B has investment interest income from A and investment interest deduction.

Maribeth

[Gretel]

Facts: A gets loan from B and then loans same to Scorp.
B get loan from Bank and loans same to A

A has interest income from Scorp and Scorp has interest deduction. A also has investment interest deduction.

B has investment interest income from A and investment interest deduction.

Maribeth

Maribeth, I always highly regard your responses but all my research points to a different answer although opinions from other professionals agree with you. I don't mean to question you since I am already sure you are right. I guess I never really understood "investment interest" and it intimidates me.

Do you have any reference for investment expense treatment for A. All I can find is interest expense to be deducted on Sch.E pg. 2 if loan is used to purchase stock.

As far as B goes: why is this not just a personal loan between father and son, why would that qualify as investment interest?

Thank you.

[veritas]

An excellent point

I think if the father and son keep the interest rate above the AFRs and avoid imputed interest there's no complications.

And/or maybe the father and son could find a better [shared, overall] income tax result if they considered a sale of the corporation's assets rather than its stock. Father might pay some tax at ordinary rate, but son could end up with a whopping amortizable intangible. Depends on what the assets [book and non-book] of the S corp are. ...or could be.

It would be interesting to know the details of this sale.

As far as deducting interest as business interest I would agree again depending on what assets are being acquired by the son.

If there is investment property as part of assets, an allocation would need to be done where some interest paid is investment interest and some would be business interest.