Why I Like Credit Card Debt In A Small S Corporation
The tax advantages of organizing as an S corporation or an LLC electing to be treated as an S corporation are significant. Self-employment taxes disappear with the corporate structure and with an S corporation there is no income tax either as all profit flows to the owners. As with all good things, there are pitfalls. The S corporation is no different.
Most small businesses in my office use the S corporation structure. There are a few rules that need to be followed, like the owners paying themselves a reasonable wage. The wage issue is easy to handle; I require S corporation clients to do their payroll in my office. Problem solved.
The other major issue with S corporations is basis. Before your eyes roll back in your head, hear me out. Basis is one of those animals many accountants screw up on or fail to track accurately. You need to have a fundamental understanding of basis if you are business owner. If your accountant messes it up the IRS still sends you the bill, not the accountant.
What is Basis?
Before we manage basis we need to know what it is. In this instance we are not talking about basis in a single asset. Our discussion focuses on your basis in your business. Basis in this instance is:
It gets a bit more complicated, but we are a family blog so we will not talk dirty. There are two types of basis you need to understand in an S corporation: stock basis and debt basis.
Problems with S Corporations
How To Take Money Out Of An S Corporation
New S Corporation business owners often ask me how to get money out of their business account and into their personal banking account.
Basically, there are four different ways to take money out of an S Corporation. In todays post, Ill outline how to get money out of an S Corp and what you should avoid during these transactions.
Repayment Of Shareholder Loans
If you have a shareholder loan that does not qualify for special exemptions, you have until the end of the corporations tax year after the year in which you received the loan to repay it without tax ramifications.
In a situation where the shareholder rules do apply and your loan is deemed to be income, if you subsequently repay the loan you can deduct the repayment.
For example, if a $10,000 loan is added to your taxable income one year, and you pay off that loan the next year, you reduce your taxable income that year by $10,000. However, if the repayment relates to a series of transactions as mentioned above, the repayment may not be deductible.
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Pay Yourself A Salary
Unfortunately, Uncle Sam wont let you take all of the money out of your S Corp as distributions, because the government wants your tax money. For this reason, the IRS requires that you pay yourself a reasonable salary for your contributions to the company. You should try to minimize the amount of salary you take while still meeting the reasonable standard.
True to form, the IRS doesnt give any specific guidance as to what reasonable means. Some factors that courts have considered when deciding whether a salary is reasonable include:
- Your training
- The type and quantity of work performed
- Prior distributions received
- The time and effort devoted to the business
Another way to look at it is to pay yourself what you would pay somebody else to do your job.
Loans To The Business
There are also benefits to treating transfers of money from owners to the business as loans. If such advances are treated as contributions to equity, for example, any reimbursements by the company may be taxed as distributions.
Loan payments, on the other hand, arent taxable, apart from the interest, which is deductible by the company. A loan may also give the owner an advantage in the event of the companys bankruptcy because debt obligations are paid before equity is returned.
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Can My Llc Lend Money To Another Llc
- Posted on Oct 13
The answers to these questions depend on a few factors. The ideal scenario is that both LLCs are single-member entities, making lending and borrowing transactions more simple. If there are multiple members in each LLC, you would have to look at your operating agreements to determine the procedures regarding lending and borrowing money, as the transaction may require a majority vote or consensus of all members. If this issue is not addressed in your operating agreement, the default provision can be found in the Florida Revised Limited Liability Company Act. Once you work through that issue, it is key to have some agreement between the two LLCs, such as a promissory note. A promissory note is a written promise to pay someone under the specified terms. This formalizes the loan, making it a legal record and ensures repayment later on. Some terms that should be included are names and addresses of the borrower and lender, amount of the loan, collateral , interest rate, and repayment structure. It is crucial that both parties sign the note to make it enforceable. Recording a loan in your books uses several financial accounts to record the loan, including cash, loan receivable and interest revenue. You should consult an experienced accountant to properly account this loan in your records.
Its More Than Numbers
Regardless of how you earn a living, theres more to income-qualifying than numbers. Lenders try to assess whether youll continue to make the same, or more, income into the future. Requiring two years of your income history, with either W-2s or business tax returns is one way they address this. They also look at what you do for a living to see if youre new to your industry/specialty or experienced. If youre new to an industry, theres more risk that you will maintain or grow your income.
Maintaining, or growing, your income is essential when qualifying for a loan and can create a hurdle for self-employed borrowers. Fluctuations in gross income or expenses are a red flag for underwriters. With red flags come questions and requests for more documents.
If this is a regular part of your industry, write a simple, straightforward letter of explanation covering the details. You can also offer an additional years tax return to support your statement. However, fluctuations due to something bad happening in your business are called declining income. Declining business income can cause a loan request to be denied. While every company is unique, you should know that if you experienced a drop in business income, it would be difficult to get approved.
Put Money Into The Corporation And Then Took It Out In The Same Year
This usually arises when an S-Corp is in its first year or two of operation. There are generally two ways to get money into an S-Corp through a capital contribution or loans . If a shareholder contributes $100,000 to their S-Corp and later distributes $50,000 to help pay their personal bills they run into a serious tax problem. The $50,000 is likely subject to the reasonable compensation rules stated above. Therefore, many shareholders will classify either the initial contribution as a loan or the subsequent distribution as a loan. In either case, whether the IRS agrees with the classification depends on how the transactions were completed.
Basics Of An S Corporation Loan
Sometimes an S corporation is short on funds and needs a fast cash infusion. A loan from a bank may not be a viable option, but a shareholder can choose to fund the business out of their own pocket. The benefit of making a loan comes in the form of getting the money repaid without the need to disburse money to other shareholders. However, repayment of the loan has to be handled carefully as it can cause the shareholder to be responsible for taxes on that income.;
The S corporation has the option to pass through losses to the owners. This can be deducted by shareholders to the total amount of their adjusted stock and loan basis. In the event the pass through is more than the shareholder’s stock basis, the excess amount of the loss reduces that shareholder’s loan basis, but it can’t be lowered below zero.;
Here’s a potential scenario: an S corporation needs an influx of capital, but the shareholders were too busy to obtain a loan and a critical payment is upcoming. One of the shareholders gives the S corporation a personal loan on the expectation that the corporation will get a loan in the near future and repay the shareholder within a short period of time. Because there is no bank note, the loan is considered to be an open account debt. In the event the corporation passes through net income in a following year, the loan basis is increased, but only to the amount that the company owes the shareholder at the beginning of the tax year.;
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Is It A Loan Or Not
To enjoy the tax advantages of a loan, its important to establish that a transaction is truly a loan. Simply calling a withdrawal or advance a loan doesnt make it so.
Whether a transaction is a loan is a matter of intent. Its a loan if the borrower has an unconditional intent to repay the amount received and the lender has an unconditional intent to obtain repayment. Because the IRS and the courts arent mind readers, its critical to document loans and treat them like other arms length transactions. This includes:
- Executing a promissory note,
- Charging a commercially reasonable rate of interest generally, no less than the applicable federal rate,
- Establishing and following a fixed repayment schedule,
- Securing the loan using appropriate collateral, which will also give the lender bankruptcy priority over unsecured creditors,
- Treating the transaction as a loan on the companys books, and
- Ensuring that the lender makes reasonable efforts to collect in case of default.
Also, to avoid a claim that loans to owner-employees are disguised compensation, you must ensure that they receive reasonable salaries.
If youre considering a loan to or from your business, contact us for more details on how to help ensure it will be considered a loan by the IRS.
The Role Of Bookkeeping
The Paycheck Protection Program requires you to self-report your payroll numbers , or your net profit if youâre self-employed. The numbers you self-report are critical for getting the right loan amount.
If you have employees , the best way to fill out your application accurately is to download a payroll report through your payroll provider. That will give you the information you need. However, once youâve been approved for a loan, itâs highly recommended that you keep accurate books for your business. Youâll need to prove you spent the funds on the appropriate categories in order to get the loan 100% forgiven. If you donât have a reliable bookkeeping solution in place, Bench can help.
If youâre self-employed, the best way to fill out your application is to get retroactive bookkeeping done for 2019 and January and February of 2020âwhich will culminate in an annual income statement. Your income statement will show your net profit, which is exactly the information youâll need. If you need a remote bookkeeper, Bench can help. Weâll do your catch-up bookkeeping for you and provide you with all the financial statements youâll need to apply for the PPP. Bookkeeping will also be essential after youâve been approved in order to get your loan fully forgiven.
If you own more than one business
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Can You Claim Unpaid Shareholder Loans When An S Corp Dissolves
When your S corporation needs money, you and your fellow owners can contribute more of your own cash to the company coffers. Another option is to make the corporation a loan. It’s possible the company may end up closing its doors before paying you back. In that case, you may be able to claim the unpaid loan as a tax loss.
Lending Money To Your Corporation
By Alan L. Olsen, CPA, MBA Managing PartnerGreenstein, Rogoff, Olsen & Co. LLP
Starting a business takes a substantial amount of money and effort. There is a correct process to go through if you want to lend money to a corporation. First, you must properly document the transaction. If you give money to your business to purchase inventory and the company defaults on the loan, you may qualify to write off the loan as a business bad debt versus an investment loss. A business bad debt can be offset against other ordinary income such as W-2 income, interest and dividend income. This type of debt can also result in creating a net operating loss on your individual return when you dont have enough income to offset the business loss.
A non-business bad debt is treated as a capital loss. A capital loss will only offset capital gains. If you realize net capital loss, you can then use the loss to offset up to $3,000 in ordinary income.
When you lend money to your corporation, the interest that you will be paid back with will be deductible to the business, but taxable to you.
Requirements to loan money to your business:
If you are considering lending money to your corporation, there are four requirements that you must meet to qualify your debt for a loan instead of equity:
The corporation must determine interest rates and payment deadlines based upon corporation profits, decision making, and other factors.
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Aicpa Asks For Guidance On S Corp And Partnership Ppp Loan Forgiveness
Taxpayers urgently need guidance on Paycheck Protection Program loan forgiveness issues, the AICPA has told the IRS, and the AICPA has made recommendations proposing solutions to those issues.
The proposed solutions came in a letter sent March 15 from the AICPA Tax Executive Committee to two members of the IRS Chief Counsels office, asking for additional guidance and making recommendations on how to apply the Consolidated Appropriations Act , 2021, P.L. 116-260, and specifically Section 276 of the COVID-Related Tax Relief Act of 2021, enacted as part of the CAA. Section 276 of the act provides that expenses paid with forgiven PPP funds are deductible, that PPP borrowers are not to reduce any tax attributes, and that no basis increase shall be denied by reason of the exclusion of PPP forgiveness from gross income. Section 276 also provides S corporation and partnership PPP borrowers instructions for the tax treatment of the amount excluded from gross income due to PPP loan forgiveness. With tax filing deadlines approaching, practitioners and taxpayers need additional guidance on these provisions.
The AICPAs Paycheck Protection Program Resources page houses resources and tools produced by the AICPA to help address the economic impact of the coronavirus.
Accounting firms can prepare and process applications for the PPP on the CPA Business Funding Portal, created by the AICPA, CPA.com, and fintech partner Biz2Credit.
Making An Investment In Your Business
The other option for putting money in your business is to invest the money. In this case, the funds go into your owner’s equity account or into shareholders’ equity .
If you withdraw your contribution, you may have capital gains tax to pay if there is an increase in the price of the shares. If you withdraw additional money in the form of bonuses, dividends, or draw, you will be taxed on these amounts. There is no tax consequence to the business on this investment.
Can You Lend Money To Your Own Llc Business
A new, small business is rarely profitable overnight. An owner might have to use personal money to nurture a new limited liability company . When the owner or owners, also called members, invest personal funds in the LLC, the infusion of cash constitutes equity or debt that the LLC must repay. If you’re thinking of lending money to your own LLC, there are some important factors to consider.
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Smart Ways To Put Money Into Your Small Corporation
Your corporation may need a cash infusion to sustain its operations. Instead of seeking new investors or a loan from a commercial lender, you may put the money in yourself. Make sure that you add these new funds in a tax-advantaged way.
Section 1244 Stock
If your business is incorporated, aim for Section 1244 stock status when contributing additional capital. This will allow you to claim a capital gain if you sell your stock at a profit, or you can claim an ordinary loss of up to $50,000 if you sell at a loss or the business goes under. . Note: Stock in both a regular C corporation as well as an S corporation can qualify as Section 1244 stock.
To qualify, all of the following qualifications must be met:
Loans to Your Business
If you own an S corporation, consider lending funds rather than contributing to capital. Loans you make to the business can increase your basis for purposes of deducting losses passed through to you, and the repayment of the principal back to you isn’t taxable.