I have a client who initially owned an S-corp 100%. At some point his spouse became an owner and it was mid-year during a tax year. In the current year they are abandoning all their assets (leasehold improvement) as the property it was renting is no longer available. The only thing on the balance sheet now are loan from shareholder, common stock, additional paid in capital and negative retained earnings. So this year we were going to write off the loan from shareholder and the company would have a gain on forgiveness of debt. Then personally, the loan can be taken as a deduction on their 1040s - from what I have found and read - it is considered a non-business bad debt and is limited to the $3000 loss per year. So I'm wondering if there is anything else we can do. We can leave the loan on the books, but the client doubts it will ever be paid back. The CS/APIC/RE would wipe out to zero.

1. Can someone give me the specific IRS section that states a loan from shareholder is considered non-business bad debt and limited?
2. Anyone have any idea of how to get a larger loss on their 1040?

Thanks!

“1. Can someone give me the specific IRS section that states a loan from shareholder is considered non-business bad debt and limited?”=========>. To the extent they have basis in the loan, the loss is a non-business bad debt on Sch D/form 8949. But generally an S-corp that has only one set of shareholders throughout its life will zero out in the end, with no capital transaction on dissolution; The balance sheet will need to be zeroed out, so the loan payable will become zero and what is left from the assets/liabilities/equity will either become a forgiveness of loan. There are ordering rules when basis is consumed. You use your stock basis before you use loan basis. If he used part of his loan basis up, he therefore should have used up all his stock basis.STCL for nonbusiness bad debt-whatever his loan basis is left after considering losses taken against his loan amount. the question is whether is was true debt or was it really capital contribution - was there promissory note, was interest paid, etc. If the loans were unpaid due to insolvency, any cancellation of debt incomewould be excludable, and have no tax effect for the S corp. Bad debts of a corporation (other than an S corp) are always business bad debts. I guess you can contact the IRS for more in detail or please visit the IRS Website here: Publication 535 (2011), Business Expenses
“2. Anyone have any idea of how to get a larger loss on their 1040?”===========> You generally cannot deduct loans made to an S Corp on your personal tax returns. But, if the corp has been dissolved, and the loans cannot be repaid, these loans can be treated as bad debts on your personal tax return with the limitation for capital loss deductions applied ;ie maximum of $3K per year.So the unpaid loans do not need to be reclassified as additional paid in capital and claimed as a loss. if the corp sells assets with a zero basis, any amounts received would be subject to capital gains and would be reported on the Sch K-1 to you the individual shareholder and can be used to repay the shareholder loans.

Thank you! The loans were made by the shareholder(s) as time went by to pay various expenses. No promissary notes were drafted nor was any interest computed over the years. They have basis in it as it was not used as debt basis. We would take it into income fully and then the clients will just have to take it as a LTCL. There is a possibility they will have gains in the future and it will be allowed sooner than later. They abandoned all their assets as they were leasehold improvements that stayed with the building. So it looks like what I was thinking is correct. Thank you so much!