Dissolving S Corp with outstanding loans from Shareholders

[gfbarkley]

Hello,

I'm trying to figure out what to do in the final tax filing when dissolving a S corp.  I'm the only shareholder.  The beginning year 'Loans from Shareholders' for Schedule K-1 is $11,000 based on ending year number from 2020.  Is End of tax year value for 2021 supposed to be reduced to zero since I'm closing the company and if so, do I account for that loan as bad debt somewhere?  The company had no income in 2021 to offset the listed loan amount.

[Rick19744 · Accepted solution]

While the facts and history are limited, I will provide some comments:

• I believe the debt should most likely be reclassified as capital.  
  • There are many factors involved, but given you are dissolving the S corp and have a shareholder loan, this appears to make sense.
• Make sure you adjust your shareholder basis schedule for the increase in capital
• This now just becomes part of the computation on gain or loss on liquidation of the S corporation
• The whole issue of debt vs equity in small corporations is a hot issue, so the above is taking the position that this should have most likely been a capital contribution from the beginning.
• Depending on the facts, if this was truly a loan, with an agreement, stated interest and actual repayments, then the S corp would have cancellation of debt income which would be passed out to you; the sole shareholder.  Then there would be the offset of a bad debt at the 1040 level, but this, depending on the facts, may be a hurdle to climb.

[gfbarkley]

Thanks for the help!