Existing S-Corp provides money to start another S-Corp

[jbrooksga]

We have an existing S-corp and using money from that business we funded the startup of another S-corp. How do we correctly classify the money in the S-corp that provided it and also on the S-corp which received those funds? 

[CuriousDom]

Here are the suggested entries:

Existing S-Corp.

Dr: Investment in affiliates (or you can use "Investment in" your new S-corp name)

Cr: Cash

New S-Corp.

Dr: Cash

Cr: Capital stock.

[Mike9241]

There's a QSUB (100% of stock of QSUB must be owned by original S_Corp) which is treated as a division of the original so only one 1120-s return (but separate accounts on the books) and the filing of form 8669. Or it could be treated as a separate S-Corp which requires filing form 2553 and 8332 if it is not a corporation.

with a QSUB separate accounts are kept on the books of the original S-corp. as a separate S-Corp the money would be record as a distribution. separate books for the new corp. 

discussion with a lawyer would be appropriate because of state laws and the fact that in certain situations the assets of both would be in jeopardy in a QSUB/S-corp but maybe not if separate corps. 

[Rick19744 · Accepted solution]

There are limited facts provided:

• You don't mention whether this is a loan or an actual investment.
• An S corporation cannot be a shareholder in another S corporation unless the ownership is 100% and a QSUB election is made as noted by @Mike9241 
• If this is just a loan, then make sure that you have a loan agreement with reasonable interest (minimum would be the IRS AFR for the month the $$ were loaned).
• The loan needs to be carefully monitored in order to not have it look like an investment.
• If the funding is a loan, then:
  • Dr. Loan Receivable XYZ S corporation (this is an asset)
  • Cr. Cash
  • The above is the entry for the loaning S corporation
  • Dr. Cash
  • Cr. Loan Payable ZYX S corporation
  • The later entry is for the startup S corporation
• Don't be penny wise and pound foolish.  Meet with a tax professional and provide them with the goal(s), etc.

[jbrooksga]

More context:

Existing S-corp A has capital to fund the business of new S-corp B. Business B purchases real estate in its own name but the down payment is paid by Business A. The intent of Business B is to rent the property in a short term fashion. After the purchase, Business A pays the expenses each month (mortgage, utilities, insurance, etc.) and also funded improvements made to the property. Plans changed for the purchased property in that it was never actually rented as intended, therefore no income has been produced to date. Even though Business B has an EIN and has S-corp status, it has so far done nothing but purchase an asset.

Every penny spent by Business A on behalf of Business B has been tracked so that classification can be adjusted if needed. 

I also thought about this from another angle. Since the capital in Business A had already been handled as income via K1s anyway, would the circumstances been different if the funds had been taken out of the business (cash distribution to officers) and then sent to Business B as owner's contribution? Is that essentially what was done here?

[Mike9241]

did you file a QSUB election? if not and you wanted QSUB status consult a tax pro for filing a late election.  However, in my opinion S-Corps are the worse type of tax entity to hold rental real estate. in non-corporate entities mortgages secured by the real estate generally can be use by the owners to increase their tax basis so losses are allowed. In a S-corp, mortgages do not add to shareholder tax basis. Losses are limited to shareholder tax basis in the S-Corp.

there is also the question of deductibility of expenses for property B, consult a tax professional. 

[Rick19744]

Follow-up comments:

• You haven't provided clear facts on the ownership of S Corp B.
  • How was the structure funded?
  • What were the expectations of the $$ provided by S Corp A?  Ownership or loan?
• S Corp A funding the overhead (mortgage, utilities, etc.) of the property purchased by S Corp B are not ordinary and necessary expenses of S Corp A and hence, not deductible by S Corp A.  These expenses are either capital contributions (assuming a shareholder) to S Corp B or additional loans.
• I also agree that holding real estate in an S corporation is not the best structure.
• I believe you need to pause immediately and consult with a tax professional before you get too far down the road and have issues and tax consequences that could have easily been avoided.