Academic journal article Journal of Accountancy

Advances to S Corporations

Academic journal article Journal of Accountancy

Advances to S Corporations

Article excerpt

Shareholders who lend money to an S corporation can deduct losses in excess of the stock basis. Recently the Tax Court considered how to compute the amount of deductible loss and the effect of a debt repayment.

Fleming S. Brooks owned 51% and Fleming G. Brooks owned 49% of the stock of Brooks AG Company Inc., an S corporation. After the shareholders deducted their losses, their stock basis was zero. Between 1997 and 2000 each of them advanced the corporation $500,000 (1997), $800,000 (December 31, 1999), and $1.1 million (December 29, 2000). On January 5, 1999, they each received $500,000 from the corporation; on January 3, 2000, each received $800,000. The corporation generated losses both years. The taxpayers argued that debt basis is determined at the end of each year; thus, they could deduct the losses and treat the repayments as nontaxable. The IRS disagreed.

Result. For the taxpayers. There are two tax rules that could apply Under section 1367, S corporation shareholders can deduct losses up to the amount of their stock basis (with a corresponding reduction in basis). When the stock basis is reduced to zero, shareholders can deduct losses equaling their loans to the corporation with a corresponding basis reduction. Future profits fully restore the debt basis and then increase the stock basis.

Normally the repayment of a loan is tax-free. However, under section 1001, if the repayment exceeds the creditor's basis in the loan, the taxpayer must report income. Thus, a shareholder has income if a loan to an S corporation is repaid before basis is restored. The court had to determine whether the basis determination occurred at repayment or at the end of the year. …

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