By: Martin M. Shenkman, CPA, MBA, JD
If you are an S corporation shareholder, you should plan to be able to utilize tax losses that pass through from the corporation to your personal return. (An S corporation is a corporation whose income is generally taxed to its shareholders, thus avoiding a corporate level tax.) In order to deduct losses, you must have “basis” (investment) in the S corporation to support the loss. If the S corporation borrows money, it will not increase your basis (in a partnership or LLC, however, it would), so borrowing has to be carefully planned. In a recent case, the taxpayer was entitled to increases in his basis for a $6 million bank loan, which he took to fund S corporation transactions. The IRS argued that because the loan repayments were sourced from the corporation, the corporation, and not the shareholder, was the borrower. That would have undermined the taxpayer’s deductions. The court, however, held for the taxpayer finding that the loan was really between the bank and the shareholder, and not between the bank and the S corporation. The IRS argument was refuted because the shareholder was listed as sole borrower on the loan and letter of credit. Further, the lender intended to treat the shareholder as the borrower. The taxpayer lost the arguments on other loan transactions. Thomas Gleason, et ux. v. Commissioner, (2006) TC Memo 2006-191. The moral is simple: have your tax adviser, and not just corporate counsel, review all S corporation related borrowing and capital infusions in advance.
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