When individuals hold a partial interest in a C or S-corporation, that can raise a number of complex issues when it comes time to file their personal tax returns. For example, many taxpayers do not know that partial interest holders may not deduct advances made to a corporation as a business expense on Schedule C of their individual tax returns.
According to Internal Revenue Code Section 162(a): Trade or Business Expense, an advance (treated either as a loan or capital contribution), is not considered a normal expense incurred in carrying on a trade or business. Instead, the IRS classifies this activity as an investment in the corporation, in which the shareholder could profit through interest on the loan, the receipt of dividends or an increase in the stock’s value. For those reasons, such advances are not deductible regardless of their characterization.
Additionally, because a corporation’s business is distinct from that of its shareholders, officers and employees, partial interest holders may not deduct current expenses that promote corporate business. However, those taxpayers may be entitled to deduct future expense on these advances. For example, if a current advance characterized as a loan later becomes an expense the company is unable (or unwilling) to repay, that would allow the taxpayer to deduct it as a bad debt expense. Similarly, if a partial interest holder advances funds as a capital contribution to the company, that person might be entitled to a future capital loss deduction if the stock became worthless.
Clearly, when individual shareholders are considering this type of activity, it’s wise to seek advice from a CPA or other qualified financial advisor. That professional is best equipped to evaluate the specific financial issues and potential tax planning opportunities generated by these types of corporate advances.
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May 2, 2017