What are the steps? -> Positive Net Income to reduce Paid in Capital thus having no taxable income?

[tschapira]

Hi TurboTax Business Tax Experts, 

I can use your guidance.  I reduced my paid in capital by paying myself back with my net income. Now, how do I document this? What forms, line items? I tried the step-by-step approach but couldn't figure it out. 

Because I used my NI to reduce my paid-in-capital, that net income should NOT be taxable. 

Please advise or let me know if I'm missing a concept/step. TYVM!

Tom

@Anonymous_ @bluedeb @xmasbaby0 @DawnC  @ColeenD3  @AmyC @MaxTax00 @DaveF1006 

[Carl]

What is structure of your business? Sole proprietorship? Single member LLC? Multi-member LLC? S-Corp? C-Corp? Partnership?

What precisely did the business "pay back" to you? A qualified loan that you made to the business? Maybe it was a return of investment in the business? Something else?

I doubt I can help, but you never know. But with more details you'll have a better chance of getting a response from someone who can help, if I can't.

[tschapira]

Hi @Carl and other Tax Experts,

My business is an LLC with S-corp status. In 2018 and 2019, I put money into the firm from personal funds (member contribution) to pay for expenses (e.g. start-up expenses, regular business expenses, etc). 

So let's say, I put $100K into the business from my personal account to my business account. Not as a loan but as investment INTO the firm. 

In 2020 taxes, I had positive NI, (e.g. $50K) and I want to use that funds as capital paid out back to me.  

I'm using forms 1120s, K-1s, Schedule M-1s, M-2s, but i don't know how to account for this.  

Thoughts or guidance? Thanks in advance. 

[Anonymous_]

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@tschapira wrote:

Please advise or let me know if I'm missing a concept/step. TYVM!

---

You are missing the concept that paid-in-capital (or contributed capital) essentially represents your equity stake in the company. 

Net income enters the taxability matrix regardless of how you want to otherwise treat it and you can either withdraw (distribute) the net income or use it for business purposes (i.e., keep it available for business use, which will increase retained earnings in an S corporation or increase partners/members capital accounts in a partnership or LLC).

Regardless, you cannot deduct paid-in-capital from net income to reduce, or eliminate, your tax liability.

[tschapira]

Hi @Anonymous_, 

I'm a single member,100% equity, so all my monies that I pour into the firm doesn't change my equity stake.  My equity stake (dollar amount) has risen because I've invested so much into it, but now I want to withdraw.

Here is a scenario

1. Year 1 - I invested $100K into the firm.  Had no income

2. Year 2 (2020), I made no investments into the firm but had 50K income

I should be able to take my 50K out of the firm and not pay taxes on my monies. Right? That's my goals.  

[Anonymous_]

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@tschapira wrote:

Hi @Anonymous_, 

I should be able to take my 50K out of the firm and not pay taxes on my monies. Right?

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No, that is not the way this works.

The $50,000 of income is subject to federal income tax regardless of how much you initially invested in the firm and regardless of whether or not you withdrew the income.

[tschapira]

If I considered it a loan, would that allow me to reimburse myself tax free?

[Anonymous_]

If you considered what a loan? 

You have to report your business income as income, that income is taxable, and it cannot be reduced by calling it something else. It can only be reduced by legitimate business deductions.

[tschapira]

Hi @Anonymous_ 

I still don't understand the concept. If I advance 100K into the business and make 50K in income, my firm is still in debt by 50K. If I'm returning 50K to myself, why do I need to pay income tax on it ? I'm still not at breakeven, my firm's books are still at a loss.

[Anonymous_]

@tschapira 

I think the point is you simply cannot make that election in this instance; you have to report the $50,000 as income and cannot choose to offset that $50,000 by claiming you are returning $50,000 worth of the loan balance to yourself.

For example, if you purchase a house and the bank lends you $200,000 (a traditional mortgage), your total mortgage payment might be around $900 per month with, very roughly, $550 of that total payment being interest and $350 being repayment of the principal balance. The bank, as a result, must report the $550 worth of interest as income and cannot offset that $550 be deducting the $350 worth of principal it received. 

When you advance a loan, the entire loan is not tax deductible currently because you expect to receive the balance of the loan back at some point in time; it is not a deductible expense.

[tschapira]

I consider this an "open debt account" as a S corp shareholder. Also Im not charging interest

Somethings a miss. Whatever I pay into the firm I should get back at the same value

[Anonymous_]

The amount of the loan has the effect of increasing your basis in your corporation.

However, you cannot deduct the funds advanced from your business income. 

At such point as the corporation repays the loan, the balance (or a part thereof) will be tax-free to you, provided you continue to have sufficient basis.

[tschapira]

Thanks @Anonymous_ 

So as an LLC S-Corp, the income is a pass through to the individual. If the corporation decides to pay off $50K in 2020, that should be tax free to the individual, right?

My entry for those payments was a debit to the member's contribution (equity line item) vs an expense. 

1. What's the correct way for accounting that?

2. For taxes, what do I need to fill out properly?

[Anonymous_]

Yes, when the corporation pays any principal on the loan, that would be tax free.

In fact, any distribution is tax free (to the extent of basis) since the shareholders have already been taxed on their share of the corporation's net income.

[tschapira]

Thanks @Anonymous_ 

Where do I indicate this:

K1 line 16D or Line 16E?