S corp loan or capital contribution?

[Samsun683]

New business (s corp) was started in 2021. For a almost the entire year , there was no income and only expenses. These were paid out of the sole shareholder’s personal bank account and totaled to a significant amount. He wants the money he contributed back. Is this a shareholder loan and we structure it with interest or is this a capital contribution? Can a capital contribution be repaid to the shareholder ? Are there tax consequences to either choice?

[tagteam]

There is a really decent article on this issue at the link below.

https://www.martindale.com/legal-news/article_boylan-code-llp_2231906.htm

[Samsun683]

Thanks I read it can you confirm my understanding. The s corp was profitable in 2021 so if treated as a loan, the repayment is not taxable because they have enough stock and debit basis? 

[Samsun683]

I’m also still not understanding when to choose capital contribution over loan? It seems a loan to me but need clarification

[tagteam]

Did you ever actually fund the corporation (i.e., contribute capital, in the form of cash, in exchange for stock)?

From what you have posted, it appears as if the corporation did not have sufficient funds to pay expenses so you had to use your personal account to do so. In that, event there is not a sufficient rationale for choosing a loan over a capital contribution (paid-in capital). 

[Samsun683]

Never provided an initial funding to it. Just set it up and started doing construction jobs through it. Therefore expenses came before income did. I guess the money is a capital contribution. But considering the owner who paid the expenses plans to collect all the money back, is that allowed when it’s a capital contribution? Or does that stay on the books forever and can only increase ? 

[tagteam]

No.

Distributions from the corporation to you (as presented on your K-1) will serve to decrease that figure. In other words, your basis increases as a result of the contribution and then decreases when you take a distribution.

[Rick19744]

Just to add some comments to your response on further clarification of loan vs capital:

• Your case is pretty straight forward since there is only one shareholder.  In this instance you completely avoid the potential non prorata distributions mentioned in the article attached by @tagteam 
• The IRS looks at several factors when deciding between the two
• One of those factors is whether there is an actual note between the shareholder and company; a stated interest rate, repayment timeframe, and whether any actual payments were made on the loan.
•  You do have the issue of attempting to get paid back when you have used debt basis to take losses on your personal tax return.  This potentially results in capital gain.
• As @tagteam noted, if you make a capital contribution your basis increases and then will decrease upon receiving a distribution.  There are rules that your AAA can't become negative as a result of a distribution, so that could cause some confusion as your M-2 and K-1 may not always agree with respect to your distributions.
• As a sole shareholder, I really don't see any reason to make it anything other than a capital contribution.  Could there be a business reason to do so, absolutely, but that doesn't appear to be your fact pattern.

[Samsun683]

Thank you so much for your detailed response. For bookkeeping, I would credit the capital account (when the expenses were paid with the personal funds during start up) and then as he draws money as repayment I would debit the capital account, right? 

On another note , the year end entry to close out RE would be to debit RE and credit  the capital account when there is a profit to increase the shareholder basis? 

are my debits  and credits right ? 

I have no experience with this and am learning as I go. I appreciate your help a lot 

[Samsun683]

Is this capital contribution considered APIC? From my research it stays on the tax return as APIC indefinitely ?

[AliciaP1]

Yes, your debits and credits are correct, and no, this is not APIC.  It would be correctly identified as Shareholder Contribution that will net against Shareholder Distributions when repayments take place.

[Samsun683]

Thank you. So when when preparing the tax return these “contributions” would be in the equity section I thought. And my software’s equity section isn’t big I can’t type in what I want. For example there’s a spot for capital and apic. So wouldn’t I enter this in apic?

[AliciaP1]

No, you would use the Capital account then.  APIC is used to identify the value over par a shareholder pays for the stock of a company.  It is not the right place to net contributions and distributions.

[Samsun683]

After further looking, the par value is 0 based on articles of incorporation.  I mistyped above. My two options to enter contributed capital on the tax return are common stock and APIC. would you put it all to APIC?

[AliciaP1]

If you do not have a section for "Adjustments to Shareholder's Equity" where you could specify "Shareholder's Contributions" or "Shareholder's Distributions" then your only option is APIC.  You cannot change the value of Capital (or Common) Stock unless there is an ownership change for the business.