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Lev
Lev, Tax Advisor
Category: Tax
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Experience:  Taxes, Immigration, Labor Relations
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My husband and I are 100% owners of an S-corporation that we

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My husband and I are 100% owners of an S-corporation that we have struggled to keep going for the last several years. We have finally filed for personal bankruptcy and are having trouble with the trustee taking issue with a "loan to shareholders" line on our business tax filing. This is a line on the taxes that has fluctuated up and down for years. No note was ever created, interest charged, payments documented etc. We did not list the "LTS" as a creditor because our accountant said it is not a real loan, just an accounting method to balance out something or other. We allowed the S Corp to dissolve at the end of 2012, we finished up a couple jobs at the start of this year that were already begun in late 2012 and have finished collecting payments & paid bills and ended up with $230 in the checking account. The accountant says we will have to file one more corporate tax return for 2013 and that's the end. The current problem here is figuring out what to do with the "loan to shareholders" for our personal bankruptcy purposes. Our accountant consulted 2 different attorneys and they both said it was ridiculous for the trustee to have a fit about the loan to shareholders line since it is worth zero as our s-corporation is dissolved and WE are the only owners - so if it was a "loan" we owe ourselves essentially. Should we just go forward with telling the trustee this is not a loan and does not affect our taxable income, as instructed by our accountant, or should we be doing something else? (like listing our s corp. as a creditor just to be sure to cover ourselves?) Our s-corp still has a loan outstanding with a bank with the company assets as collateral. Physical assets are worth virtually nothing. Should we be concerned that the bank would try to pursue collection of something labeled "loan to shareholders" - the accountant thinks not because it is not worth anything and not an actual loan with a contractual note. The stock is not worth anything, there was never any actual stock funding at the start of the corporation, it was just an arbitrary number selected by our attorney when we incorporated the company. (original value designated as $18K, the final "loan to shareholder" value was about 15K, with the last 5K being added on in this last tax year of 2012. This is SO confusing!
Submitted: 1 year ago.
Category: Tax
Expert:  Lev replied 1 year ago.
First of all - S-corporation is a separate legal entity - and because of that a "loan to shareholders" is a real loan - as long as there is an intention to pay it back.
If based on your information - no note was ever created, interest charged, payments documented etc - that might be interpreted - you had no intention to pay the loan back - and the moan must be considered as either wages or distribution to shareholder at the time it was paid.

That is not a "loan" you owe yourselves as you might view it - because S-corporation is a separate legal entity.
Essentially - the loan must be repaid to S-corporation - and distributed to you out of S-corporation as part of liquidation distribution. If that will occur - for tax purposes - your the liquidation distribution you would receive should be treated as a sale of S-corporation shares and your taxable gain depends on your basis in S-corporation stock.
Your concern is very valid - if S-corporation owes to other creditors - creditors might try to get rights to the "loan to shareholders" - and your obligations to pay back to S-corporation could be transferred to obligations to pay other creditors.
It is impossible to advise in any specific action - but the risk of such outcome is relatively high especially if creditors know about these loans. You definitely need to discuss that issue with your bankruptcy attorney.
Sorry for your situation.
Customer: replied 1 year ago.

I'm confused about the middle paragraph: "Essentially - the loan must be repaid... and distributed to you... as part of liquidation distribution..." If a creditor of the s-corp is a lienholder of all assets, wouldn't the repaid money go to them before it would be distributed to us?" - And we don't have any way to pay back this money anyway.


 


Also, the creditor does not know of the "loan to shareholder" accounting that we are aware of, though I suppose they would've had a copy of our tax return when the loan was being approved 5 yrs ago and the loan to shareholders was on the tax documents then, but I'm not sure for how much.


 


Although we don't have documentation or a legal note/contract physically created on the "loan", the number has fluctuated up and down, being reduced & increased through the years, showing "repayment" in effect. I think we should list our s-corp as a creditor in our personal bankruptcy but if it's not "really a loan" would that be fraud? I believe the bankruptcy questions include the demand that you list "anyone" that you owe or think you owe so that nothing gets missed in the petition so I think it should be listed.


 


On the other hand, if we go the route of "its not a loan", then are we supposed to file amended tax returns for 2012 for money received/not paid back, or can we do that in 2013? I believe our income has been low enough that adding the approximately 15K to our income would not disqualify us from our chap 7 filing.

Expert:  Lev replied 1 year ago.

I'm confused about the middle paragraph: "Essentially - the loan must be repaid... and distributed to you... as part of liquidation distribution..." If a creditor of the s-corp is a lien holder of all assets, wouldn't the repaid money go to them before it would be distributed to us?" - And we don't have any way to pay back this money anyway.
As long as there is no collateral - the priority is based on timing.
However creditors might request to change priority because you are officers of S-corporation.

Also, the creditor does not know of the "loan to shareholder" accounting that we are aware of, though I suppose they would've had a copy of our tax return when the loan was being approved 5 yrs ago and the loan to shareholders was on the tax documents then, but I'm not sure for how much.
I do not think that you want to inform creditor about the this loan. That is not in your interest - and unless there is a clause in your loan contract - you are not required to inform them.

Although we don't have documentation or a legal note/contract physically created on the "loan", the number has fluctuated up and down, being reduced & increased through the years, showing "repayment" in effect. I think we should list our s-corp as a creditor in our personal bankruptcy but if it's not "really a loan" would that be fraud? I believe the bankruptcy questions include the demand that you list "anyone" that you owe or think you owe so that nothing gets missed in the petition so I think it should be listed.
That is correct - according to your information S-corporation (as a separate legal entity) IS your creditor and should be listed.
However the most likely reason - your accountant listed that amount as a loan to shareholders - because you were not able to provide supporting documentation about how these money were used. If it's not "really a loan" as you stated - you need to find out where are these funds.

On the other hand, if we go the route of "its not a loan", then are we supposed to file amended tax returns for 2012 for money received/not paid back, or can we do that in 2013? I believe our income has been low enough that adding the approximately 15K to our income would not disqualify us from our chap 7 filing.
That is correct - if that is not a loan - and funds were not spent on any business expenses - most likely - they were used for your personal purposes - while you still need to verify where the money went.

The IRS specifically mentioned - When corporate officers perform services for the corporation, and receive or are entitled to receive payments, their compensation is generally considered wages. Subchapter S corporations should treat payments for services to officers as wages and not as distributions of cash and property or loans to shareholders.
see here - http://www.irs.gov/uac/Wage-Compensation-for-S-Corporation-Officers

Customer: replied 1 year ago.

This should by my final inquiry about your answer/info:


 


Yes, the money did essentially go to us for our use as the accountant said this is money taken out by us but not accounted for in business expenses so then it was placed in the "loans to shareholders" column.


 


So, if the money was just taken out by us, why would we need to "still need to verify where the money went" if it is just going to be recategorized as wages?


 


And does that mean we need to do an amended tax return for 2012? If so, do we indicate the amount added to the loan in 2012 of about $5K as our additional wages that year (that's how much the loan-line was increased by in 2012) or do we have to declare the whole 15K because the company is dissolving? Can't we just do the $5k this year, then adjust for the other $10K in the final tax return in 2013? Honestly, we can't go back and amend taxes for the last 15 or 20 years that this "loan to shareholders" thing has existed.


 


It seems to me that calling it wages solves all our problems (except adding taxes due) as there is no longer any "loan" outstanding for a creditor of the s-corp to try to collect on, and we should still qualify to file bankruptcy I think.


 


But calling it a loan and listing the corporation as a creditor would see this debt discharged - which would also solve our problems and not involve additional taxes and refiling of returns. Our accountant insisted it is not a loan, just an accounting method and we have paid taxes on all income to the IRS so there is nothing we have to do with it. The value of the stock is zero and the value of the corporation is zero. The accountant said 2 other attorney's she consulted thought the trustee was a nut/idiot and she has done many audits with clients and the IRS didn't bat an eye at the "loan to shareholders" accounting. Your thoughts?

Expert:  Lev replied 1 year ago.

Yes, the money did essentially go to us for our use as the accountant said this is money taken out by us but not accounted for in business expenses so then it was placed in the "loans to shareholders" column.
Thank you for confirmation.

So, if the money was just taken out by us, why would we need to "still need to verify where the money went" if it is just going to be recategorized as wages?
No issues if that was a payment to you - and you plan to amend your tax return reporting that payment as either wages to officers or as distributions to shareholders.
Wages to officers would be deductible for S-corporation and taxable to recipients. But distributions to shareholders are maid out of shareholder's capital account - it will not be taxable but will reduce shareholder's basis. If the basis is reduced to zero - it is taxable as a capital gain.

And does that mean we need to do an amended tax return for 2012?
That is correct - if distribution to shareholders was incorrectly reported - to correct - you need to amend your tax return.

 

If so, do we indicate the amount added to the loan in 2012 of about $5K as our additional wages that year (that's how much the loan-line was increased by in 2012) or do we have to declare the whole 15K because the company is dissolving?
That is possible.
However - if the corporation is dissolved - all balance items must be zeroed - and the full amount which was not correctly reported should be paid off now - or will be treated as distribution.

 

Can't we just do the $5k this year, then adjust for the other $10K in the final tax return in 2013? Honestly, we can't go back and amend taxes for the last 15 or 20 years that this "loan to shareholders" thing has existed.
That is possible - but honestly - by doing this way - you cover one incorrect reporting by another incorrect reporting.
I know that many shareholders are doing this way - but legally that is not correct.

 

It seems to me that calling it wages solves all our problems (except adding taxes due) as there is no longer any "loan" outstanding for a creditor of the s-corp to try to collect on, and we should still qualify to file bankruptcy I think.
That is not "calling it wages" - these payments are actually wages - because they were paid to you as officers as a compensation for services - and you had no intention to pay it back.

But calling it a loan and listing the corporation as a creditor would see this debt discharged - which would also solve our problems and not involve additional taxes and refiling of returns. Our accountant insisted it is not a loan, just an accounting method and we have paid taxes on all income to the IRS so there is nothing we have to do with it.
Let be honest - if your accountant reported wages as loans and called that "an accounting method" - you might want to seek a different accountant. However for years you accepted that method to avoid employment taxes of wages.

 

The value of the stock is zero and the value of the corporation is zero. The accountant said 2 other attorney's she consulted thought the trustee was a nut/idiot and she has done many audits with clients and the IRS didn't bat an eye at the "loan to shareholders" accounting. Your thoughts?
If your basis in corporate stock is zero - any distribution to you as a shareholder (not as employees) must be reported and taxed as capital gains. When unsporting as distribution but hiding under "loan to shareholders" you avoided income tax liability for years building a pyramid scheme that may not last forever. I think that is a "creative" accounting practice - and the best resolution would be to include that amount into your income now. However if audited - that might be classified as a fraud with intention to avoid tax liability - all you might be assessed additional penalties for past years. That is the worst case scenario - and I hope you could avoid such development.
I would verity the contract you have with your accountant - if he/she could be held liable in this case.

Sorry if you expected differently..

Customer: replied 1 year ago.

Thank you for your time & effort. I have just had a long discussion with my husband and am now aware I was completely confused about what this whole thing was about. The stock value was originally stated at 18K when the corporation was started. At the end of each fiscal year, if we don't have un-deppreciated assets of at least 18K (in the form of physical assets/(equip)/cash in the bank etc.) then the difference is put into a column titled "loan to shareholders" and has nothing to do with actual money changing hands and affecting profits & losses, wages/distributions or the like. The balance in this column has fluctuated over the years simply because we have had depreciation of equipment, additional purchases of new equipment, and of course, varying year end balances of cash on hand in our business bank account. All monies have been accounted for each year, and all taxes were paid accordingly. I thought incorrectly that this was some form of accounting for cash we have received but was way off base. It finally makes sense now WHY our accountant was always asking us what the year end balance was in our business account. We didn't understand what that had to do with taxes or anything else - we just gave her the info and she would do the calculations and plug in the number accordingly. Yay! It's nothing after all and now we can explain it to the trustee. Though your replies are not needed, I appreciate all your effort & apologize for taking up your time needlessly. I will however, pay for your services since I used them. Thank you very much and have a great day :)

Expert:  Lev replied 1 year ago.
That would be an easy resolution if your accounted listed accumulated depreciation under "loan to shareholders."
That is misleading - but if not connected to actual distribution - that would be just a matter of correcting your last tax return.
You might need to attach a letter with explanations because you may not simply eliminate the "loan to shareholders" balance.
If above is correct - there should not be any issues to explain to the situation to the trustee - but you might need to provide additional information and calculations to support your statement.
That would be a huge relief and I wish you the best resolution.
Customer: replied 1 year ago.

Our account always has a depreciation schedule form/thing with our taxes so I think that is covered and so we don't need to amend our tax return. (though you said to "list accumulated depreciation under 'loan to shareholders'". I don't recall a line on the tax form anywhere near or under the loan to shareholders item, but as I said, there is a whole form devoted to a depreciation schedule so does that suffice?


 


I like the fact that you pointed out we need to show additional supporting documents & calculations to show how this number results. That will be very helpful I'm sure, so the trustee can see how it all works. Excellent! Thanks again! I need to head out for a couple hours, but I will return & check for your reply & pay at that time. HUGE THANKS!

Expert:  Lev replied 1 year ago.
No issues - take your time.
Nevertheless - as that amount was not connected to any unreported distribution - that would not require to amend any previous tax returns - still you need to deal with 'loan to shareholders' balance - on the final tax return - and it should be re-classified with explanations attached to your tax return.
If that is only on your internal books - no issues.
However if loan to shareholders are reported on your tax return - verify form 1120S schedule L line 19 - http://www.irs.gov/pub/irs-pdf/f1120s.pdf
then you would need to deal this that balance.
Customer: replied 1 year ago.

Thank you LEV,


 


When you said we don't need to amend any previous tax returns, but would need to deal with it in the final tax return, you are referring to 2012 and then 2013 correct? (no need to amend most recent return for 2012, and we will need to attach a note of explanation to the final tax return for 2013 that says what exactly? Should it say, "It is being reclassified because it was listed as a loan to shareholder incorrectly, when it is actually a (fill in the blank)." I'm sure I can ask our accountant what she thinks it should say exactly, but am wondering what you think the note should say so it is clear. Do we need to spell out that it was an internal accounting item that was classified incorrectly on the return or something like that?


 

Expert:  Lev replied 1 year ago.
There is no specific form and there is no specific wording - all depends on your circumstances.
However you may not simply eliminate the loan to shareholders without paying it back.
If that amount becomes zero and the loan was not paid back - you need to explain the situation. That is something you need to discuss with your accountant and the person you prepares your tax return.
If you change the classification - you need to explain to which account it was changes and why.
Generally - based on your explanation - that was an error that you are planing to correct.
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 22704
Experience: Taxes, Immigration, Labor Relations
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