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Paid in capital vs loan from shareholder




For an "S" Corporation, is it more advantageous to classify money paid into a business by shareholders as paid in capital or as a loan from shareholders?
Thank you!


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There is no answer. If they are capitalizing the corporation with cash, it simplifies things. If they are transferring in assets that have a low basis and they issue debt to themselves, they very well may have triggered taxable income.
Will they need to obtain additional financing? If so, banker would rather see paid-in capital even though they will require the stockholder debt to be subordinated.
Stockholders of S corporations are notorious for having short memories: They loan the company $10,000, pay themselves 3 checks of $5,000 each and will swear on a stack of Bibles that the company still owes them $5,000.
Another issue is stock basis. Usually companies lose money when they first begin operations. Repayment of debt that was included in basis for deducting losses will trigger taxable income.
Take a look at this link.
http://www.taxalmanac.org/index.php/Dis ... _of_s_corp
A pretty good rule of thumb is the 3:1 rule mentioned in the above article. If you have not had experience in this before, suggest you invest a little money with a really good tax practitioner and treat it as an educational as well as business investment.


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I can never thank you enough for the wealth of information you provided!!
One more favor, would you recommend a good reference book, guide or text book on S Corporation accounting/bookkeeping?
Again, thank you!!


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Can't really recommend a good book. I have been preparing S corporation returns for quite a while. When I have a questions, I just research the answers. Maybe someone else can jump in and make a suggestion.
I have seen a couple of books on Amazon.com about S Corporations that cost less than $25.00 each. May I suggest that you check out a book about this subject and print out the instructions for 1120S. Read a section in the book and then refer to the 1120S instructions for the IRS explanation. Once you are ready to prepare a return, fill out an S corporation return by hand even if you have S corporation software.
Remember that S corporations are still corporations.
If you have specific questions, contact me by email and we can resolve them.


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Sandy S wrote:
I can never thank you enough for the wealth of information you provided!!
One more favor, would you recommend a good reference book, guide or text book on S Corporation accounting/bookkeeping?
Again, thank you!!
Hi
There are many available on net for free. You just have to surf it out with correct or related keyword.. I am sure you will get the one you are looking for. Best of luck.


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Like a C Corporation, S corporation generally is based on the company's legal entity in the country organization. S corporation shareholders is a separate legal entity, and in accordance with national laws, usually given the responsibility to provide the same C's shareholders to protect their shareholders. Federal income tax purposes, however, S corporation is similar to tax partnerships. As with partnerships, income, deductions, and a shareholder of S Corporation tax credits flow through each year, either by distribution. Therefore, the income tax level of shareholders, rather than at the enterprise level. Paid by the company distributed to shareholders tax-free, the content is undistributed earnings before tax level. In addition, punitive tariffs on some enterprises (for example, the accumulated earnings tax, personal holding company tax) and the alternative minimum tax does not apply to an S Corporation


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I would record it as capital stock and APIC and contributions from the s/h to the corporation. Any distributions would decrease his basis, but a loan needs to be an arms length transaction with interest being charged and paid to the s/h and then reporting that interest income on the s/h individual return at year end. If it is a LOAN and the s/h wants the money paid back in installments, then the s/h loan approach is the correct approach. However, I agree with LJ on the capital stock and apic.


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APIC is not a tax concept, but rather a legal concept. For tax purposes, common stock and APIC are treated as one, except perhaps where you have some thinly capitalized corp issues (not an issue on topic here). As far as eroding APIC, in a redemption or in case of a treasury stock, you may reduce APIC. But this will depend on your state's specific corporate law as to how GAAP would look at it. Again, not really a tax issue. But to get to your real question on the imputed interest...if your shareholder is considered a related party under Sec 267, and your shareholder is cash basis, the C corp would not have been able to have deducted the interest expense until the shareholder recipient recognized the income. Alternatively, if the shareholder is accrual based, the shareholder would have had to recognize the imputed (accrued) interest regardless of the tax method of accounting of the C corp. Assuming that the shareholder is in fact cash basis and related under Sec 267, I suggest that you calculate all interest due, and pay it to the shareholder along with the principal (if that is what the corp and shareholder want). The corp deducts the interest expense at time of payment, because under the matching principle the shareholder is picking it up into income at that time. Of course, being so close to the end of the year, you may want to consider waiting until 1/1/2010 to defer the expense/income, depending on what is in the best interests of the corp and shareholder.