Hello and thanks for trusting me to help you today. I am a tax adviser with over 15 years of experience.Interest payments made to the shareholder are reportable by the shareholder as income.
When the company repays a loan where the shareholder’s debt basis is less than the face value of the loan, the shareholder must take a portion of the repayment into income. Revenue ruling 64-162 calculates the income by dividing the reduction in basis by the face value and multiplying the quotient by the repayment amount.IRC section 1271(a)(1) provides that retirement of debt instruments are exchanges. 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.
Another expert advised that I may not have been direct enough in relation to your question. I had answered above "Interest payments made to the shareholder are reportable by the shareholder as income". For the sake of being clear the incoem is interest and would reported as interest by the shareholder.
If the S-corp borrowed directly from a bank instead of the S-corp's owner borrowing the money on the S-corp's behalf, the interest paid on the loan would be deductible by the S-corp and the owner does not report interest income. Given the initial scenario where the owner borrows the money from a bank on behalf of the S-corp because the S-corp does not qualify for a bank loan, why is the loan interest paid by the S-corp to the owner treated as taxable income when the loan interest received by the owner is used to repay to the bank?
The simpliest answer is because the S corp is an entity and the interest deduction is being taken by the S corp. As they are related (the 100% owner and the S corp) both must treat the interest as same. The S corp would deduct but the shareholder is required to include. I may not be explaining it in a way that is clear. If you need I can opt out and we can see if another can state teh situation in a way that is different.
I would rather you get an explanation that is clear. Sometimes another person can say it in just the way that is clearer.
OK. Thank you.
Another expert will pick it up pretty quick. I will opt out now and thank you