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Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 3992
Experience:  Juris Doctorate, CFP and MBA, Providing Financial & Tax advice since 1986
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Hi, The owner of a S Corp has used the greater part of his

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Hi, The owner of a S Corp has used the greater part of his basis. His basis included original capital, shareholders loan and profits. Basis was reduced by use of early losses and then distribution in the profitable years. The company is now in a position where it can pay the owner back the shareholders loan. My question is . . . if the company pays the shareholder loan, must he pay taxes on that amount? As it was part of his basis and used, how does he report it, if at all? Thank you
Submitted: 1 year ago.
Category: Tax
Expert:  Lane replied 1 year ago.

NPVAdvisor : Hi
NPVAdvisor : Since stock basis has to be reduced to zero before debt basis is available, any distributions in excess of stock basis would be includible in the shareholder’s income as capital gains.
NPVAdvisor : As the corporation repays the debt, the debt basis decreases.
NPVAdvisor : If flow-through losses have depleted stock basis, subsequent basis increases first must restore debt basis.
NPVAdvisor : Nake sense?
NPVAdvisor : Now, in terms of whether it's capitl gain or income?
NPVAdvisor : THAT depends on the nature of the loans in their hands. IRC section 1271(a)(1) provides that retirement of debt instruments are exchanges. Thus, if a loan is evidenced by a note, the income portion of the repayment is considered capital because the note is considered capital in the shareholder’s hands. If the loan is an “open account,” or a loan not evidenced by a note, the income portion of the repayment is ordinary income.
NPVAdvisor : I still don't see you coming into the chat ... Sometimes it helps if I move us to the Q&A" mode ... we can still continue a dialogue there, just not in real-time as we can here
NPVAdvisor : Let me know if you have further questions
NPVAdvisor : If this HAS helped, I would appreciate a feedback rating of 3 (OK) or better. That's the only way they will pay us here
NPVAdvisor : BUt again, if you need more on this, PLEASE COME BACK here, so you won't be charged for another question
NPVAdvisor : Thanks
NPVAdvisor : Lane
Expert:  Lane replied 1 year ago.
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Customer: replied 1 year ago.
Hi thanks I just want to make certain I understand completely. If the basis is zero and the shareholder loan is paid by the corporation and if the capital account is sold, may I assume the owner must pay taxes on the total whether income or capital gain?
Expert:  Lane replied 1 year ago.

Yes, that's correct.

Here's an excellent article form the Journal of accountancy on the issue.

They talk about using capital rather than debt because of the issue (as a planning issue) ...

... but there's good explanation of how/why the repayment creates taxation.

The answer to you question, however, IS yes.

See this:

http://www.journalofaccountancy.com/Issues/2004/Nov/AvoidTheTaxTrapWhenRepayingShareholderLoans.htm

Thanks
Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 3992
Experience: Juris Doctorate, CFP and MBA, Providing Financial & Tax advice since 1986
Lane and 2 other Tax Specialists are ready to help you
Expert:  Lane replied 1 year ago.

Thanks so much Paula.

If you'd like to use ME again, just say "For Lane only," at the beginning of your question.

Thanks again,
Lane

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