Loan to shareholder

[snowdog]

Hi,

Question:
A 'C' Corporation records personal use of the company credit
card by a shareholder in a "Loan to Shareholder" account.
The balance in this account fluctuates as the shareholder
pays the company back for these expenses.

However, there has been a balance carried over from one year
to the next; and interest was not accrued. Now the company
is reporting a NOL for the past 2 years.

How can the company get this off the books without the
shareholder writing a check? Could it make a return of
capital distribution (since there is no profit to do regular
dividend distribution). If so, I understand that to the
shareholder, the return of capital distribution is not
taxable until it exceeds the shareholders basis... after
which it is a capital gain.

Appreciate your help and feedback.

 

[Hamlet the Prince]

However, there has been a balance carried over from one year

to the next; and interest was not accrued. Now the company
is reporting a NOL for the past 2 years.

How can the company get this off the books without the
shareholder writing a check? Could it make a return of
capital distribution (since there is no profit to do regular
dividend distribution). If so, I understand that to the
shareholder, the return of capital distribution is not
taxable until it exceeds the shareholders basis... after
which it is a capital gain.

A distribution out of the C corp will not be a dividend if
the corp has a deficit in its accumulated and current
earnings and profits. If the NOL's for the last 2 years
wiped out all of the prior year undistributed earnings, then
the C corp would have a deficit in its accumulated earnings.
If the corp also has a deficit in its current year
earnings, then any distributions during the current year
would not be treated as dividends.

If the distribution is not treated as a dividend, then it
will first be treated as return of capital to the extent of
the shareholder's basis in the shares. To the extent the
distribution exceeds the basis, the distribution will be
treated as proceeds on the sale of the stock (generally
capital gain).

 

[snowdog]

Thank you for your reply, I appreciate it!
A couple of follow-up questions:
1) Is this a viable solution for settling the shareholders
debt to the company? Do you think such transactions attract
the attention of the IRS... a red-flag?
(There is a deficit in accumulated earnings, and the debt to
the company is greater than the shareholders basis, so there
would be some capital gain then.)

2) Is there a "problem" in the IRS' eyes that the company
carried this debt for more than a year (it's been kind of
like a revolving debt).

Thanks again.

 

[Hamlet the Prince]

Is this a viable solution for settling the shareholders

debt to the company?
Yes.

Do you think such transactions attract the attention of the IRS
... a red-flag?
(There is a deficit in accumulated earnings, and the debt to
the company is greater than the shareholders basis, so there
would be some capital gain then.)

Should not attract much attention.

2) Is there a "problem" in the IRS' eyes that the company
carried this debt for more than a year (it's been kind of
like a revolving debt).

The IRS may argue that the "loan" from the corporation to
the shareholder was not a loan, but instead was a "dividend"
(they would have an incentive to make this argument in a
year when the corporation had positive earnings).

If no interest has been charged on the loan, the IRS may
impute interest on the loan. This means likely
nondeductible interest expense by the shareholder and
taxable interest income at the corporate level. They may do
this for all open tax years. With interest rates so low
(and NOL's at the corporate level), this would NOT likely be
a significant cost.