Academic journal article Journal of Accountancy
Acquiring Basis in S Corp Shareholder Loans
Practitioners routinely face the challenge of helping S corporation shareholders increase their basis for purposes of deducting pass-through losses under IRC [section] 1366(d)(1). Often, planning to increase basis will result in shareholders making loans to the S corporation at yearend. In situations involving shareholder loans to S corporations facilitated by borrowings from a related entity, such as back-to-back and circular loans, the Tax Court continues to require that shareholders make an "economic outlay" to acquire basis.
Under the economic outlay doctrine, to obtain basis in a loan to an S corporation, a shareholder must make an actual economic outlay, the outlay must somehow leave the shareholder poorer in a material sense, and the debt created must run directly between the shareholder and the S corporation. Therefore, practitioners need to exercise care in the construction of shareholder loans to S corporations to provide the best opportunity for increasing basis for deduction of losses.
Practitioners advising on proper methods to use for shareholders to acquire basis in loans made to S corporations incurring losses should bear in mind several key issues:
* Identify S corporations with basis limitation issues as soon as possible to emphasize to shareholders the importance of structuring S corporation loans as coming directly from shareholders and to minimize last-minute recharacterization of advances from related entities as back-to-back loans from shareholders.
* Properly document, through interest-bearing promissory notes and contemporaneous corporate minutes, shareholder loans to S corporations. …