Why would a shareholder of a closely held construction company owe the company money and have it show as a debit loan/receivable on the company books? Let’s consider some possible explanations:

• The shareholder is using the corporate checkbook for personal expenses that are reflected as a loan;
• The shareholder needs to borrow funds for acquisition of property and is using the company for the down payment. It may be business-related: For example, the down payment could be needed to purchase an owner-occupied property in which the construction company is located and is now paying rent; or
• At the end of the year, distributions are reclassified to a receivable to ensure there were not distributions in excess of basis taxable to the shareholder.

Regardless of the reason, money has left the company and a debit shareholder loan must now be addressed. This article will cover the tax issues associated with such loans, focusing on implications to S corporations and their shareholders.

Determine If the Receivable Is a Loan

The main issue to consider is whether the shareholder receivable is truly a loan, which has several tax implications. If it’s not truly a loan, the IRS could argue one of the following:

1. Are the amounts actually additional taxable compensation? This would result in an increased deduction to the company and increased ordinary taxable income to the owner-shareholder subject to employment taxes.
2. Are the amounts actually a constructive dividend? Here, the result is potential taxability as ordinary income or capital gain.

If the debit loan account is in fact a loan for tax purposes, then the IRS could still argue that the interest that has yet to be charged (or paid) for below-market rate loans should be subject to additional taxable income.

Key Factors

Numerous cases¹ debate if shareholder advances are bona fide loans. Courts view this as a factual question that should be determined based on all of the surrounding facts and circumstances: “For the disbursements to constitute loans, there must have been, at the time of the transfers, an unconditional intention on the part of the transferee to repay them, and an unconditional intention on the part of the transferor to secure such repayment.”²

To determine if there is intent to repay the shareholder advances, courts analyze several key factors, including:

Shareholder-Corporation Relationship³

• How much control does the debtor-shareholder have in the corporation? Are the loans arms-length transactions?
• Does the debtor-shareholder have the ability to repay the advances without access to additional corporate funds?
• Has the corporation enforced collection of the receivable?