I have a profitable S-Corp that loaned $56k to a recently failed LLC. I need to make sure I make the correct journal entries. Can someone help?

[jeff5]

The LLC failed in 2016 and did not repay the loan, or effectively defaulted. I need to make sure I make the right journal entries.

In the LLC I made the following entries:

I debited the  Loan Account $56k

I credited Member Investments account $56k

For the S-corp I made the following entries:

I debited the loan account $56k

I credited the expense account "Bad Debt" the $56k.

Does that sound right? From what I understand the $56k should show up as income for the LLC and then show up as a loss or expense for the S-Corp. Am I doing this right?

[TaxGuyBill]

What was the purpose of the loan?
Are you also a member of the LLC?

[jeff5]

I own both the S-Corp and the LLC. The LLC was failing and but had a lot of outstanding debt. The debt payments had to be made, but the LLC was not making any money. So I had the S-corp loan money to the LLC. Then in December of 2016 (last month) the LLC closed and defaulted on the loan to the S-corp.

[jeff5]

To clarify, the S-corp is owned by my wife and myself with 51/49% of the shares. The LLC is also owned in a similar fashion with 51/49%.

[TaxGuyBill]

So the S-corporation didn't really have any business reason for the loan?  In that case, because of the "related parties", in my opinion it was a loan to shareholder (you and/or your wife) and the loan still exists.

[Rick19744 · Accepted solution]

Based on your facts, my thoughts and comments are as follows:

• The S corporation had no reason to loan money to the LLC.  As such, I believe you made a distribution from the S corporation to yourself for the $56,000.
• Then you personally contributed the $56,000 to the LLC.
• When the LLC closed, you then have a capital loss on your "investment" to the LLC.  This loss is technically what your remaining basis is in the LLC.  As an example, if the LLC started out with zero basis, you contributed the $56,000 so you now have $56,000 basis.  If the LLC lost $$ in 2016, then this loss will pass through to you and also reduce your basis.  Whatever this remaining basis is, represents your loss.  Since the contribution was only made just recently, the loss is a short term capital loss.
• Since you and your wife own each, the distribution out from the S corporation and the contribution to the LLC needs to be based on your respective ownership.  This is critical for the S corporation as distributions need to be in relation to ownership.

[jeff5]

Thanks for your answer. I did some more research and I think I can still proceed in the 'general' manner I planned and categorize the loan to the S-corp as a "Non-Business Debt" (IRS publication 550) and take a short term capital loss using form 8949 for the taxes with the S-corp. I don't believe I'll have to categorize this as a distribution from the S-corp to shareholders. Note: There is a reason I want it to flow and be any type of expense with the S-corp....that company made some good money in 2016! I need to make sure my 'reasonable salary' is truly reasonable when compared to my net profits. That's a different topic in itself.

[jeff5]

I do still have some questions though regarding this plan. 1) Even with a short-term capital loss does the loss show up on the P&L statement? (I only partially grasp accounting principles). 2) I need to make sure this shows up correctly on the taxes for the LLC. Do I need to issue the LLC a 1099-B and categorize the defaulted loan as income/revenue?

[jeff5]

Also as a side note, just so you know I'm trying to do this correctly and legally; I did catch that I'll need to file/include extra items with form 8949 when I file the S-corp taxes. I'll need to attach a statement to the return that contains the following as described by IRS publication 550:  
• A description of the debt, including the amount, and the date it became due;
• The name of the debtor, and any business or family relationship between you and the debtor;
• The efforts you made to collect the debt; and
• Why you decided the debt was worthless. For example, you could show that the borrower has declared bankruptcy, or that legal action to collect would probably not result in payment of any part of the debt.

[jeff5]

Looks like the S-corp will need to issue a 1099-C to the LLC for the cancelled/defaulted debt (not 1099-B).

[Rick19744]

I will respond to your follow-up point and questions:

1. You should be able to support the position noted.  While I have not run the figures, I do believe you end up in the same economic position.
2. The S corporation should issue the LLC a form 1099-C.  This cancellation of debt will be income to the LLC.
3. The LLC will file a final 1065 and K-1's to the members
4. Yes this "loss" will show up on the S corporation.  You previously had the note set-up as an asset (note or loan receivable).  You will credit this for whatever the amount is to zero it out and the debit will be capital loss for the P&L.  This short-term capital loss will be separately stated on the K-1's.
5. Yes you should include an attachment with the information you noted.
6. Nice work on your part on attempting to figure all this out.  Kudos to you.