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Taxes on a repaid S corporation loan
Dear Tax Talk,
I have a consultancy business, and the company
is registered as an S corporation. In the past, I had loaned funds
to the company to sustain the operation. Now that the company is profitable,
I want to get the loan paid back to me. Obviously, the money I had
loaned was personal funds and I had already paid taxes on it. This
is not an expense item for the company (balance sheet item) and thus
cannot be deducted as an expense. This increases the profit that flows
to personal income, as it is an S corporation. Am I not ending up
paying taxes twice on it?
S. Haider
Dear S. Haider,
An S corporation is a flow-through entity for tax purposes. The income and the losses of the company flow through and are reported on the shareholder's income tax return.
If you had to lend money to the S corporation in earlier years, it means the company was either operating at a loss or was accumulating assets. If the company had losses, then you would have claimed the losses on an earlier tax return using the money you lent as your basis for claiming the loss.
Now that the company is producing profits, it can repay your loan. But the loan's basis, which has been reduced by the amount of prior losses, is adjusted for the amount of profits.
For example, assume you lent the company $10,000 in
prior years and it lost $9,000 and had $1,000 remaining in its bank
account. The company's balance sheet would look like this:
| Cash in bank |
$1,000 |
Due to Stockholder |
$10,000 |
| |
|
Accumulated Losses |
($9,000) |
| Total assets |
$1,000 |
Total liabilities and equity |
$1,000 |
Based on this, you should have claimed $9,000
in losses on your prior returns. Your loan's basis is adjusted down
to $1,000.
Now assume the company makes $10,000 so that it has $11,000 in the bank and can pay you the whole $10,000 back. The company has $10,000 in profit that flows through to you individually and it restores your basis in the loan back to the full $10,000 plus leaves you with a basis in profits (stock) of $1,000. The company can repay you the whole $10,000 loan plus it can give you the remaining $1,000 without consequence.
When all is tallied you would have paid tax on $1,000, which is $10,000 in profits less the $9,000 in prior losses and you would have gained back $11,000 which is your original $10,000 plus the $1,000 gain on which you pay tax.
A similar result occurs when the company is accumulating
assets. In this case, you're gaining a tax cost in these assets
that the company is earning so that later these assets, when converted
to cash, can come to you tax free.
-- Posted: April 1, 2004
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