Assuming that a shareholder owns 100% of an S-Corp and the same shareholder also owns 30% of C-Corp (completely different companies and industries). Both companies have posted a loss for 2013. To help the C-corp to meet payroll, the shareholder borrowed 9,500.00 from the S-corp and loaned to the C-Corp in January of 2013. The loan was repaid in Februay of 2014 (which the shareholder then used to pay back the S-Corp). The question is:

1) Knowing that the loan is less than $ 10,000.00, should the S-Corp charge interest from the shareholder?

2) Should the shareholder then charge interest from the C-Corp?

Dear SapoJow,

The short answer is yes. Please remember that when it comes to taxes each transaction stands alone. While it may seem like a "wash." If the S-Corp made the loan and then failed to declare the interest from that loan, regardless if it was paid or not, the IRS could impute the value of the loan, using fair market interest rate(s), and then attach penalties, if appropriate, and interest on the unpaid taxes owed.

Additionally the auditing agency, usually the IRS but it could be the State, could use the excuse of the undeclared interest to justify an audit of the person(s) for which the undeclared interest should have flowed through to the partner(s) via the K-1.

I am intentionally ignoring State taxation issue(s) that such a failure to declare may cause.

My final piece of advice is to either; become very familiar this issue at the Federal and possibly State levels, or find a competent tax professional in your area that is qualified to handle, and advise you.

Best regards,

Ron Fenney
Tax Accountant
Only Tax Appeals
Fountain Valley, CA

Your answer was very helpful. Thank you very much!

1) Yes. When the Sc orp loans money to the C corp, then It's a loan like any other loan. As long as the arrangement is legitimate, there is generally nothing wrong with loaning funds to another entity in an arms-length transactions with adequate interest charged. The problem that often arises is that the bookkeeping is not done, or agreements are not prepared and years from now it often becomes difficult to discern who owed how much to whom, when and for what. This is when it becomes a problem. You would provide a promissory note to the S-Corp with terms and interest payable to the
S-Corp for the loan. By providing a promissory note and paying interest it should prevent the IRS from re-classifying the loan as a distribution.





2) correct; the IRS expects that for any loans that are made to a C corp are properly recorded on the balance sheet of the Corp as a Liability under a section called loans from Officers/shareholders.Furthermore, there should be proper documentation on the corporation minutes that approves such shareholder loans to the corporation. This loan must be accompanied by some formal interest rate payable on this loan, a loan period should be specified along with the amount of monthly repayment. If the corporation is not able to make timely monthtly repayments on this loan then a proper interest accrual is to be made on the loan, in other words the books should record interest paid to the shareholder. This accrual or interest paid must be aggregated at end of the year and a 1099-Interest is be prepared on the total interest paid to the shareholder (or amount accrued) and reported to the IRS.This means effectively, that the corporation would be expensing the interest paid on its books, and the shareholder/officer of the corporation will be reporting interest income received from the corporation or accrued on the books of the corporation. If the above rules are not observed, the IRS can impose penalties and interest on the individual shareholder/officer for underreporting income and can also recharacterise these loans as additional paid in capital instead of loans. This is a more serious outcome and consequences are that the shareholder would not be able to be repaid on his loan!