- Open account debt cannot exceed $25,000 per shareholder at the close of the year
- If a shareholder loans more than $25,000 to a single S corporation in a year, the shareholder may have to report income on repayments
- S corporation shareholders may increase their basis in indebtedness only if they end up paying off the loan they guaranteed on behalf of the S corporation
- These regulations are important to you and your shareholders if your basis in your open account debt is reduced for prior pass-through losses, or if you have loaned money to, or guaranteed a loan for, the S corporation
- For key definitions related to this topic, jump to the end of the document.
Regulations define "basis of indebtedness of the S corporation to the shareholder" as the shareholder's adjusted basis in any bona fide indebtedness of the S corporation that runs directly to the shareholder.
Currently, open account debt cannot exceed $25,000 per shareholder at the close of the year. For example, an S corporation with ten shareholders could have up to $250,000 of open account debt as long as no single shareholder advances more than $25,000. If the balance of the indebtedness at the end of the year exceeds $25,000 for a shareholder, the entire amount is no longer considered open account debt and the shareholder may have to report income on repayments.
In general, if a shareholder's basis in a debt has been reduced by pass-through losses from the S corporation, gain must be recognized by the shareholder if the corporation pays down the debt. Therefore, repayment of open account debt may result in ordinary income for shareholders.
The rule for guarantees is distinguished from the general rule for adopting a bona fide indebtedness standard. Regulations hold that S corporation shareholders may increase their basis in indebtedness only if they end up paying off the loan they guaranteed on behalf of the S corporation.
These regulations are important to you and your shareholders if your basis in your open account debt is reduced for prior pass-through losses. Additionally, if you have loaned money to, or guaranteed a loan for, the S corporation you may be subject to these regulations as well.
- Open AccountAccount that has a nonzero debit or credit balance that is kept open in anticipation of future transactions.
- Open Account DebtA shareholder advance that is not evidenced by a note. Typically, open account debt refers to when a shareholder makes multiple loans to an S corporation throughout the year. Repayments and advances are treated differently for open account debt than for a shareholder loan evidenced by a note. Open account debt cannot exceed $25,000 for the year.
- Bona Fide IndebtednessFactors that the courts consider in determining whether a bona fide debt exists as the result of a transfer between related parties include:
- Documentary evidence of the transaction such as an executed note
- Whether there is a fixed schedule for repayment, including a maturity date
- Whether interest is being charged on the outstanding debt
- Whether collateral is obtained or requested
- Whether demand for repayment is made
- Whether any repayments have been made, and
- Whether the transaction is reflected as a debt in the books and records of the parties
- Basis in a DebtBasis in a debt is simply how much the loan is worth after adjustments. Direct loans you make to the S corporation from your own resources increase your loan basis. Loans others make that you merely guarantee don't count unless you pay the loan. You must adjust your loan basis at the end of each tax year. After making the adjustments, the final result is your adjusted loan basis.
- Increase your loan basis
- Additional loans to the corporation
- Deferred (unpaid) interest added to the loan
- Decrease your loan basis
- Repayments of principal
- Debt forgiven by you
- Principal amount of a loan converted to stock
- Your share of net loss in excess of the adjusted basis in your stock (This is where you may have to recognize a gain on your loan to the S corporation.)
- Pass-through Losses from S corporationsLike pass-through income, losses are also passed-through to shareholders, but the total deductible amount available is limited to the original investment amount.
Our comments may not contain a full description of all the facts or a complete exposition and analysis of all relevant authorities. Furthermore, the use of certain words such as “should, would, or will” is merely for grammatical convenience, is not intended to indicate a specific level of authority regarding a particular issue, and no explicit or implicit references should be taken there from. Our comments expressed herein are based upon the provisions of the Internal Revenue Code and Regulations in force on the date hereof, all proposed amendments to these Acts, Regulations and treaties publicly announced by the relevant authorities. Each and all of these authorities are subject to change at any time. Any such change could be given retroactive effect with respect to the transactions described herein and could cause the conclusions provided to become invalid, in whole or in part, with respect to any entity involved. There can be no assurance that these authorities will not disagree with, or challenge, the views set forth in this memorandum or that any such challenge will be unsuccessful.