Tax Implications of Debit Shareholder Loans

Why would a shareholder of a closely held construction company owe the company money and have it show as a debit loan/receivable on the company books? Let’s consider some possible explanations:

  • The shareholder is using the corporate checkbook for personal expenses that are reflected as a loan;
  • The shareholder needs to borrow funds for acquisition of property and is using the company for the down payment. It may be business-related: For example, the down payment could be needed to purchase an owner-occupied property in which the construction company is located and is now paying rent; or
  • At the end of the year, distributions are reclassified to a receivable to ensure there were not distributions in excess of basis taxable to the shareholder.

Regardless of the reason, money has left the company and a debit shareholder loan must now be addressed. This article will cover the tax issues associated with such loans, focusing on implications to S corporations and their shareholders.

Determine If the Receivable Is a Loan

The main issue to consider is whether the shareholder receivable is truly a loan, which has several tax implications. If it’s not truly a loan, the IRS could argue one of the following:

  1. Are the amounts actually additional taxable compensation? This would result in an increased deduction to the company and increased ordinary taxable income to the owner-shareholder subject to employment taxes.
  2. Are the amounts actually a constructive dividend? Here, the result is potential taxability as ordinary income or capital gain.

If the debit loan account is in fact a loan for tax purposes, then the IRS could still argue that the interest that has yet to be charged (or paid) for below-market rate loans should be subject to additional taxable income.

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