S Corp Shareholder Debt (open account v.s. formal note)

[Ayhn]

I have a client which is a small S Corp with just one owner. The owner has a Shareholder Loan account to track her personal money paid for business and/or business account paid for her personal expenses.

The SH Loan account balance as of 12/31/2023 is more than $25,000, and I have a suggestion diagnostic from ProConnect: The program detected an open account debt with a loan balance at the beginning of year greater than $25,000. Open account debt with a prior year-end balance of more than $25,000, should be classified as a formal note at the beginning of the tax year and must be separately tracked. US - Ref #57034

My questions are:

(1) what's the proper way to convert the open account shareholder loan to a formal note in QB and in ProConnect?

(2) After making the beginning balance as a formal note, do I need to leave it as is and start to separately track current year shareholder loan in the Shareholder Loan account (open acct debt)?

MANY THANKS!

[qbteachmt]

"and/or business account paid for her personal expenses."

And now they need to stop that nonsense. This shareholder formed a corporation, and this commingling of funds defeats that purpose. Yes, the shareholder might need to fund the corporation. No, the business never pays for personal expenses for the shareholder.

Is this the first year of these activities? If you net the two activities, do you have loan from the shareholder or loan to the shareholder?

You've used the phrase "open account" which is further indication she thinks this is her very own private bank. It's a separate and incorporated entity. Let's treat it as such.

That message is to flag you, and your shareholder needs to understand that the IRS requires imputed interest with this type of activity, because it isn't supposed to be treated so casually.

Google this:

shareholder loan over $10,000

And read a lot of the results

[Ayhn]

Thanks for your reply. The net result is that the company owed her $25k+. She normally doesn't pay personal expenses from business account, just a few transactions by mistake I believe. So, back to my questions, if I need to convert the Loan from Shareholder to a formal note, what shall I do? Thanks.

[sjrcpa]

Have her draw up a note with adequate stated interest and repayment terms.

[qbteachmt]

"if I need to convert the Loan from Shareholder to a formal note"

You not so much converting it as documenting it and formalizing it. In the bookkeeping, it should already have been tracked as borrowed funds (or as additional paid in capital) and not as income. Just like her personal expenses are not expenses for corporate tracking. This all is Balance Sheet activity.

[workhard2022]

Thank you for sharing your knowledge! If the shareholder paid for business inventory out of her pocket. I recorded this as a " Loan from the shareholder" in the bookkeeping (balance sheet). Can I reclass it to " additional paid-in capital" later? any limitations or requirements to do this? Just considering if I can avoid reporting this "loan from the shareholder" on form 7203.

[workhard2022]

Additional question:   same case as " S-corp and only 1 shareholder."  It has a $150,000 loan from a shareholder ( $4000 from the first business year 2021; $140,000 from the tax year 2022; $6000 from the tax year 2023). Is this one loan or multiple loans?  I am not sure if I should count it as multiple loans and then use "the "Shareholder Multiple Debt Basis" input" in form 7203. 

Thank you for everyone's help!

[sjrcpa]

Whether it is a loan or contributed capital is decided by the shareholder.

[qbteachmt]

"Whether it is a loan or contributed capital is decided by the shareholder."

A follow up recommendation is to meet with the CPA (or find one) to figure out what is happening here. Those are some pretty big and ongoing numbers, so there likely needs to be an overview and plan, and not just, "What to do with these values for tax prep" because you now listed large values that overlapped multiple year ends. If there are ongoing losses, the shareholder won't get repaid; if there are profits, the shareholder should have been repaid or at the least, paid the interest or some sort of "settle up" activity. This is beyond an internet posting. It might mean amending prior returns.

[Numbers-Sleuther-Nyssa]

Hi, Ayhn:

If the company owes her the money, then you should move the money to a Loan Payable account or instead of making it a loan, make it a Distribution.