ownership percentage vs. basis

This post will no doubt reveal my gross ignorance on this topic, but a colleague of mine has an issue that made me realize I didn't understand a very fundamental matter in regard to corporate ownership. Two gentlemen formed a corporation (s-corp election), each contributed an equal amount of capital and co-signed on a loan. Both claimed a loss two years running (which pretty much wiped out their original contribution). Last year, one of the shareholders paid off the loan. Now, as typical of many poorly-advised clients who started corporations, they probably never issued stock or ever had a board meeting. Has paying off this loan affected the ownership of the business, or just their individual basis? Thanks.

Reply to
Brew1
Loading thread data ...

what was their intent? Was the shareholder who paid off the loan making a loan to the corporation to do so? Was he buying a greater share of the corporation by adding assets? What is the corporation doing? Is it a going concern?

Reply to
Wallace

If they don't have a written agreement from which the answer can be determined, there's no universal answer. In the normal case the law considers shareholders to be owners in the same proportion as their capital contributions, unless there is an agreement otherwise.

Reply to
Stuart A. Bronstein

Well, it depends.....

Assume two shareholders - A and B each 50% owners.

A pays off loan- personally.

B does nothing and has no change in basis.

What was the intent when A paid off loan?

It could be treated as A loaned the money to corp that paid off loan. Therefore no change in ownership. A has same basis in stock and now also has basis in stockholder loan to corp. No change in ownership percentage.

It could be treated as A added capital to corp by buying more stock. This generally requires an agreement by a majority of shareholders to issue more stock. If this is case, A has increased stock basis and increased ownership percentage. B has no change in basis but does have decreased ownership percentage. If this is the case, be careful of allocating profit or loss which needs to consider the date of new stock purchase.

Corp really needs to get up to date with stock certificates, bylaws, minutes, etc. Also if a stockholder loan was created, there needs to be loan documents.

If I were preparing these returns, I would require proper documentation of these items before completing the returns.

Reply to
CMS_VA_CPA

Thanks for the responses--this agrees with what one of our resident CPA's told us, that there could be a written agreement whereby ownership remains at 50-50.

Reply to
Brew1

Right. But the capital accounts would have to be adjusted to reflect any difference in contribution level, unless some other arrangements are made (e.g. the corporation gives a note to the over-contributing shareholder to repay him for the excess contribution).

Actually loans from shareholders are common in small corporations. This is at least in part because repayment of a loan is not taxable to the shareholder (except for interest) while any other distribution might be subject to tax. Generally total loans shouldn't exceed three or four times the amount of the capital contributions, however.

Reply to
Stuart A. Bronstein

If this gets treated as a loan there better be a loan agreement. The IRS has recently issued NEW GUIDANCE on stockholder loans that are going to bite a lot of small corporation owners in the ASS big time. There are new timing, repayment and basis calc rules under these guidelines.

Agreed - but it could also be treated as A adding Additional Paid In Capital which MIGHT merely increase his cost per share basis in his 50% holding.

Without Question - I truly believe that the new small corp loan guidelines issued recently by the IRS are intended to close some of the gaps that have been used for years to play basis games allowing stockholders to deduct losses.

AGREED Gene E. Utterback, EA, RFC, ABA

Reply to
Gene E. Utterback, EA, RFC, AB

BeanSmart website is not affiliated with any of the manufacturers or service providers discussed here. All logos and trade names are the property of their respective owners.