Have a Tax Question? Ask a Tax Expert
The payment generally must be made and the income included by the related party in order for the entity to deduct the unpaid expense.
"Unpaid expenses owed to related party. If you use an accrual method, you cannot deduct interest and other expenses owed to a related cash-basis person until payment is made and the amount is includible in the gross income of that person. The relationship, for purposes of this rule, is determined as of the end of the tax year for which the interest or expense would otherwise be deductible. If a deduction is denied under this rule, this rule will continue to apply even if your relationship with the person ceases to exist before the amount is includible in the gross income of that person.
This rule generally applies to those relationships listed in chapter 4 under Related Party Transactions. It also applies to accruals by partnerships to partners, partners to partnerships, shareholders to S corporations, and S corporations to shareholders.
The postponement of deductions for unpaid expenses and interest under the related party rule does not apply to original issue discount (OID), regardless of when payment is made. This rule also does not apply to loans with below-market interest rates or to certain payments for the use of property and services when the lender or recipient has to include payments periodically in income, even if a payment has not been made. "
The general rule that payment must be made does not apply to loans with below-market interest rates. In that case the entity can take the deduction without payment when the income is included by the related lender.
Yes, if the corporation is on accrual based accounting and this was a below market interest rate loan.
No, if the corporation uses cash accounting or if this was just unpaid amounts on a loan that was at market interest rates.
I hope this helps to clarify for you.