Repayment of loan to shareholder. Single member S-Corp

[Jack from Ohio]

I am trying to understand something a colleague challenged me on.

Single member S-Corp. Tree service business. Been in business 15 years.

Business fluctuated over the years. Losses and profits. Annual gross income avg. $450K

Negative retained earnings of approx. $13K

Owner has W-2 earnings of $69K. Corporate profit this year, $10K.

Owner has loan to corp of $30K. Took $15K repayment of loan in 2013.

Colleague says the repayment of the loan is taxable to the owner/shareholder due to the shareholder having 0 basis.

My thoughts are: Being a single member, it is not possible for him to have 0 basis. Therefore the repayment of the loan is not taxable.

Please weigh in with your thoughts. This is a $4k tax difference on the owner's personal return.

[jklcpa]

You have to work through the basis worksheets. It is possible that your colleague is correct. Also, the repayment of the loan can be either capital gain income or ordinary income, depending on the structuring of the loan. If the loan is evidenced by a note, it's possible that the repayment will be capital gain income. If the loan is "open" with no documentation in place, the taxable income triggered by the repayment would be ordinary income.

 

http://www.journalofaccountancy.com/issues/2004/nov/avoidthetaxtrapwhenrepayingshareholderloans.htm

[Jack from Ohio]

You have to work through the basis worksheets. It is possible that your colleague is correct. Also, the repayment of the loan can be either capital gain income or ordinary income, depending on the structuring of the loan. If the loan is evidenced by a note, it's possible that the repayment will be capital gain income. If the loan is "open" with no documentation in place, the taxable income triggered by the repayment would be ordinary income.

 

http://www.journalofaccountancy.com/issues/2004/nov/avoidthetaxtrapwhenrepayingshareholderloans.htm

Single owner. How does a single owner have 0 basis? That is the part that confuses me.

[jklcpa]

You didn't give enough info yet for anyone here to compute his basis.  Clearly there were losses or distributions in prior years that created that negative balance in retained earnings, but we don't know if aggregate prior year losses were enough that stock basis has been reduced to -0- by the start of the year you are working on, and if there was a reduction in debt basis prior to the BOY.  Was debt basis at BOY a reduced amount below 100% of its value?

 

Basically, there is stock basis and there is debt basis. Once stock basis is zeroed out, the shareholder can continue to deduct losses on his personal return up to the amount of debt basis. If both have been fully used, then his basis is truly -0-.  If the debt basis had been reduced below its face value, any repayments of the loan that are paid to the shareholder might create taxable income. The character of that income depends on the type of loan.  The shareholder's basis doesn't have to be -0- to create this income, only that debt basis had been previously used (reduced) when he deducted losses, and if repayment of the loan is made before the debt basis is restored to 100% of face value, then he will have income.

[kcjenkins]

I agree with Judy.  Doesn't happen often, but it can.  Need to do a worksheet anyway, so that you can defend whatever you determine is the correct tax treatment.

[Abby Normal]

Single owner. How does a single owner have 0 basis? That is the part that confuses me.

Many of my single member s corps have 0 stock basis at year end some of the time, or even a lot of the time. It happens because of having debts/loans that do not increase stock basis, and do not provide debt basis. Debt basis is very restrictive in s corps. It's much easier in partnerships. They use those debts to buy assets that are 179'd or bonus depreciated to zero, wiping out income or even showing a loss. If they take too many distributions, their stock basis will hit zero and excess distributions are taxed as capital gains.

 

I NEVER let any of my s corps have loans payable to shareholders, because it's too much of a pain to deal with loan repayments where debt basis was used to deduct losses. Also, imputed interest. I always move the loans to paid in capital to increase stock basis. Keeps things much, much simpler and that's always a priority for me.