How do I claim as a deduction a personal payment on my family farm's S corporation debt?

[ahazlegrove]

I receive a K-1 from the family's S corporation.

[TaxGuyBill]

Personal payment for what?  A farming expense?
Did the corporation reimburse you?
Do you work for the corporation?
Do you receive also a W-2?

[ahazlegrove]

The farming expenses include the corporation's farm debt service (machinery, repairs, feed & seed, etc.); No, I am not of salary.  No, I am not on the payroll.  I am a minority stockholder, but I am uncompensated for my labors.  I don't receive a W-2 from the farm corporation, just a K-1 showing my share of the corporation's income & expenses.  My brothers are the only salaried family members; both of them live and work on the farm.  I don't.

[ahazlegrove]

Thank you for your response to my question.

[TaxGuyBill]

Wow, there are several problems with your situation.

First, if you do any work for the corporation and the corporation is profitable, you are REQUIRED to be on payroll.

Why did the corporation not pay for the expenses, or reimburse you for the expenses?  Even if the corporation didn't have any money to pay for it, the best way it should have been handled is that you should have made a Capital Contribution to the corporation, and then it could have paid for the expenses.

Without wages, you can't deduct it as an Employee Expense.

While it is POSSIBLE that it could qualify as an "Investment Expense", I personally do not think it qualifies.  It is NOT "ordinary" or "necessary" for you and the corporation to have handled the expenses that way, so I don't think it qualifies for that.

Bottom line is that I don't think it qualifies as a direct deduction at all.  However, because you "contributed" materials to the Corporation, that probably qualifies as a Capital Contribution.  That needed to be recorded on the Corporate return.  If that was done, it is still not a direct deduction, but it adds to your "basis" in the Corporation.

I think that you and the Corporation will greatly benefit from going to a tax professional to learn how a Corporation needs to operate.
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[Rick19744]

I think this should be treated as a loan to the S corporation so you can be made whole.  I also sense some family dynamics that probably need to be resolved; ie: why you are paying the expenses of the corporation, why you are providing services and not being compensated, etc.

[ahazlegrove]

Rick, Thank you for taking the time to respond to my query.  The farm has been in the family for multi-generations.  My father and mother incorporated it some 30 years ago.  Since that time, farm economics, especially dairying, have been tough.  In fact, my siblings and I inherited a large debt load on the farm, and in spite of great management and a lot of hard work, most years it operates at a loss.  To keep from paying interest on interest, several of us have chipped in to pay farm bills to keep the debt load from increasing even more.  We don't want to lose it like so many other family farms.  Every little bit helps to pay the bills or to keep them from increasing due to loans needed to operate and pay expenses.  My livelihood does not depend on the farm's success like it does for my siblings and their families who work and live on it.

[Rick19744 · Accepted solution]

Understand the issue and makes sense.  

However, based on your facts, you cannot derive any tax benefit by paying some of the expenses of the S corporation. In fact, this could lead to problems if you won the audit lottery and this were audited by an astute agent.

What is happening here is you are paying expenses of the company.  The IRS could take the position that you have technically made a capital contribution, technically increased your ownership and as a result your distributions of allocable income / loss are disproportionate.  This would lead to a loss of your S corporation status.  Not good.

Additionally, if the IRS looked at this they could take the position you have technically made capital contributions, which could lead to other problems.  A contribution to a corporation is tax-free if certain requirements are met.  One of those is the receipt of property in exchange for the "cash", which would be stock; you have not done this.  Additionally, there is the control test which requires the transferor(s) of property to be in control of the corporation “immediately after the exchange.” This control threshold is 80% and you clearly do not meet this test.  The deemed contribution of capital could lead to a taxable event.

So after some long discussion of some tax issues that you probably did not want to hear about, there is really nothing you can do to obtain a tax benefit and could even lead to a tax detriment.  The loan to the company is really the only option you have and based on your facts, does not sound like it is feasible.

Best of luck keeping this family farm moving forward.