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mihosakai
Level 2

owner capital contribution tax

we have S corp.  the owner lend money to company for years and now the owners (2 owners 50/50) want those money to capital contribution.  so that the company does not owe anything to the owners.

I understand that owners capital contributions are taxable to the owners as its pass through..   lets say the owner lent money to the company ($500 each month) and after years, it accumulated to $20,000.  and the owners decided that these are capital contributions from the owners (each owner equal amount).  this year, the company was loss (net income) with $50,000.  does it mean that the company loss is $30,000 (50-20) and no tax is incurred to owners?  or still the owners have to pay tax for their contributions?

and how to record this to quickbook desktop?

3 Comments
john-pero
Community Champion

owner capital contribution tax

The discharge of debt owed by the S corp in and of itself has no direct effect on the equity basis of each shareholder but on the general income of the company. Thus you cannot directly exchange debt for equity. If only one shareholder loaned money to the corporation and that loan is canceled it does not upset the balance of equity among the shareholders.  The year of a loss would be am excellent time to wipe the debt off the books and record the associated income. And that is all you do, using a journal entry , for example, you would debit the loan(s) and credit an income account you add specifically for the debt forgiveness.

 

If the corporation has a $50k loss before forgiveness of $20k then after forgiveness the book loss is $30k, which then is passed through equally to the shareholders. At least that is my interpretation. For tax issues like this you are always best to consult with a tax CPA.  But here is some info from an online legal firm

https://www.stimmel-law.com/en/articles/cancelling-debt-practicalities-and-tax-results

 

S CORP DEBT WRITEOFF

An S corporation derives income when a creditor discharges the S corporation from a debt. The income derived from the cancellation of indebtedness of an S corporation is not distributed to the shareholders of an S corporation. However the income that each shareholder derives generally from an S corporation is subject to taxation.

For taxation purposes, an S corporation and its shareholders are considered two separate entities. The method adopted for taxing an S corporation and partnership is the same. But the rules adopted for distribution of Cancellation of Debt Income (COD) in an S corporation are different from that of a partnership.

As mentioned earlier, the income of a shareholder does not increase with the cancellation of indebtedness. It is only the general income, tax credits, and deductions of the S corporation that are distributed at the shareholder level. As an exception to the general rule, the income that arises from the discharge of debt that is made before October, 12, 2001 and March, 1, 2002 under the bankruptcy proceedings is distributed among the shareholders.

However, the liability of an S corporation in insolvency, bankruptcy and indebtedness is not distributed at the shareholder level of an S corporation. Similarly the income that is received from the discharge of debt due to insolvency and bankruptcy is distributed at the corporation level and it is not distributed at the shareholder level.

Occasionally, a loss incurred by an S corporation is also not distributed among the shareholders. Hence such losses are considered income to the shareholders and it is called Net Operating Losses (NOL). An NOL is reduced from the gross income of the S corporation. The income derived from the discharge of indebtedness is also excluded from the gross income of an S corporation.

john-pero
Community Champion

owner capital contribution tax

The other thing you might have to account for is imputed interest over the years. The IRS does not take kindly to loans that carry no interest.

 

Imputed Interest Definition (investopedia.com)

 

So the debt may actually be significantly higher than just $20k

mihosakai
Level 2

owner capital contribution tax

Thank you for the quick response.  this is very helpful information.  asking this question to CPA cost $$$$.  I will make sure to add the interest.  i will record the forgiveness with $20K + interest. does this work?

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