How to handle S Corp owner contributions that are greater than distributions taken?

[david3]

S Corp 100% owner contributed $200K+ more into his business than the amount of distributions taken. He incurred a huge loss in 2021 due to legal expenses related to an ongoing lawsuit. This is the reason for his additional contribution.

For banking and other purposes he would like this additional amount to be shown in the equity section of the balance sheet.

How do most of you handle this situation?

I know a lot of tax preparers report this as a shareholder loan to the corporation. However, with these small S Corps there never is a loan agreement and no interest is charged.

If it is reported as "Due to Shareholder" then it is reported as a current liability on the balance sheet and no basis is reported either.

I don't think it should be reported as Additional Paid in Capital since the owner intends to get the money back as soon as possible. For instance, if the owner takes more distributions than he has basis the next year or the following year then he can't reduce APIC for the excess distributions.

I want to check to see if any of you know a way to handle this that will give the taxpayer basis and show the additional contributions in equity.

Thank you.

[IRonMaN]

"For banking and other purposes he would like this additional amount to be shown in the equity section of the balance sheet"

You can't have the best of both worlds.  Either it is equity or it is a loan.  If he is going to be paying himself back as soon as possible, that sure sounds like a loan and not equity to me.

[jeffmcpa2010]

If there was no "concurrent in time" paperwork that would normally be in place for a loan, then it would not be a loan. (I'm talking about a written note, including appropriate interest and specified repayment terms.)

If it is not a loan, then it is in fact additional capital contributions which go to the equity section.

It really does not matter if it is Additional Paid In Capital, as with him being the sole owner of the S Corp, he can take distributions at any time without tax consequences so long as they do not exceed his tax basis in the Corp.

BTW If he gets additional bank loans, you may want to ask to review all the loan covenants to be sure that there are not restrictions on distributions, so you can advise him about when he can return his investment without violating those covenants.

[david3]

So he can take future distributions in excess of retained earnings (to pay himself back) against APIC? I thought distributions could not be reported against APIC and could only be reported against RE.

If this is the case, then APIC is the best solution. Please confirm that I'm not misreading or misunderstanding your answer.

Thank you.

[jeffmcpa2010]

You could be right on the repayment, now that you phrase it that way, I'm not entirely sure, as I haven't run through that situation in a number of years.

EDIT:

I did just find this on google

"S corporations, in general, do not make dividend distributions. They do make tax-free non-dividend distributions unless the distribution exceeds the shareholder's stock basis. If this happens, the excess amount of the distribution is taxable as a long-term capital gain."

I had been thinking that it was Basis that mattered that distributions not exceed, and I feel like this says the same thing

[david3]

Yeah, I haven't ran into this before. That's why I want to make sure I handle this correctly.

I can't find anything that seems to address this situation. Research on APIC seems to indicate that distributions don't reduce APIC but can only be reported against RE.

However, in future year(s) as the shareholder is paid back, if the distributions are reported against RE and the "pay back of additional contributions" originally reported on the balance sheet as APIC are reported as reducing APIC, wouldn't that be acceptable?

Is there any reg that says APIC can't be paid back to a 100% S Corp shareholder? Is the expectation that if there is a reduction in APIC that there is a deemed sale of stock to the shareholder? I don't want the reduction in APIC to cause an IRS red flag in the future.

Thanks for your help.

[david3]

Sorry, Jeff. I didn't see your last post before I sent my last post.

OK, so the shareholder will get basis for his contributions in excess of distributions. Is the correct way to handle this still to record it as APIC?

Then, as my last post addresses, when the company pays back the APIC, it will be reported as reducing APIC and basis. It will not be recorded as Distributions. 

My concern is that if the tax return balance sheet shows a reduction in APIC, does the IRS expect to see a deemed sale of stock holder shares?

Thank you. 

[sjrcpa]

You don't reduce APIC for Distributions.

You cannot make AAA negative because of  distributions.

As stated already, shareholder can take distributions without tax consequences as long as they don't exceed his basis.

[jeffmcpa2010]

@sjrcpa 

I think you are correct that any distributions go first to Retained Earnings (AAA).

If Retained earnings gets reduced to 0, and you still have basis that you want to distribute does it go on line Schedule L line 25, and to Schedule M-2 Column D - Other Adjustments Account?

[david3]

Ok, maybe I'm confusing things with semantics.

I know you don't reduce APIC with distributions.

When the company pays back the shareholder for his contributions that were reported as APIC, can that amount be reported, not as a distribution, but as a reduction in the shareholder's APIC account without raising red flags?

The $200K amount the shareholder contributed in 2021 would be reported on the Basis Info Wks as Stock/loan contributions under the Stock Basis column. Accordingly, this amount would increase APIC on the Schedule L balance sheet since it isn't reported on Sch M-2.

As Jeff pointed out, this would increase the shareholder's basis.

Is this the correct way to handle this situation?

Thank you.

[sjrcpa]

"When the company pays back the shareholder for his contributions that were reported as APIC, can that amount be reported, not as a distribution, but as a reduction in the shareholder's APIC account without raising red flags?"

No. You don't reduce APIC for distributions. Distributions reduce retained earnings, maybe making RE negative. They reduce AAA but cannot make AAA negative."

"The $200K amount the shareholder contributed in 2021 would be reported on the Basis Info Wks as Stock/loan contributions under the Stock Basis column. Accordingly, this amount would increase APIC on the Schedule L balance sheet since it isn't reported on Sch M-2.

As Jeff pointed out, this would increase the shareholder's basis."

Correct.

[david3]

Thanks @sjrcpa.

I understand that you don't reduce APIC for distributions. That's why I am saying that the amount paid back to the shareholder for his additional cash paid into the business is not reported as a distribution but is reported as a reduction of APIC. No distribution, just paying back the additional cash the owner had to put into the business.

Are you saying that the APIC can't be paid back and that any money paid back to the shareholder is still reported as a distribution against RE? And even if RE goes negative from distributions that the shareholder still has basis since there is an APIC balance?

Sorry to drag this out. I really appreciate your help.

[sjrcpa · Accepted solution]

"Are you saying that the APIC can't be paid back and that any money paid back to the shareholder is still reported as a distribution against RE?" 

Yes

"And even if RE goes negative from distributions that the shareholder still has basis since there is an APIC balance?"

Shareholder still has basis because he still has basis.

[david3]

Got it now. 

Thanks so much for your help. 

[sjrcpa]

You're welcome.

[TAXPROFPHD]

Your best bet is to treat it as a contribution to the capital of the S Corporation for which you will receive basis. The loan route is problematic. The accounting is fairly simple:

Debit -- Cash 

Credit -- APIC

[SRP]

I'm having the same issue, except the shareholder is using the contribution for personal expenses, which only runs through the balance sheet.  Should they be excluded from the S corp altogether to prevent triggering future audit?

[daleoempire]

This makes sense, and you can even throw in common stock to that journal entry if the entity actually has common stock and want's to issue new stock.

My question however is what reduces APIC then? Shareholder distributions reduce retained earnings, so what then reduces APIC for S-corporations? I can understand that if the corporation buys back the shares at a higher price. But that doesn't seem practical for an S-corp that's really an LLC or partnership that made the S-corp election? So that does mean APIC stays on the books indefinitely?

[sjrcpa]

"does mean APIC stays on the books indefinitely?"

Yes, unless there i a redemption.

[qbteachmt]

"except the shareholder is using the contribution for personal expenses, which only runs through the balance sheet."

Why? What are they trying to accomplish?

This often happens when someone thinks, by running it through their independent entity, they turn it into a business activity.

"Should they be excluded from the S corp altogether to prevent triggering future audit?"

They need to stop treating the corporation as their personal bank. It's called Commingling and it's known as Piercing the Corporate Veil. What they did is expose their personal life to the business of the corporation and the corporation's business to their personal life. One example is Lawsuit filing against assets recoverable for damages and settlement. And they just made it all discoverable in the case of IRS audit, bank review, worker comp compliance, you name it, they revealed it.

They formed a corporation for a reason. Then they took it out behind the shed and shot it to death.

[daleoempire]

That makes perfect sense! Thank you!

I have seen many people play around with the APIC when their balance sheet doesn't balance. I'm surprised the IRS doesn't flag these returns that have a change in APIC without a correlating change in ownership of the S-corp.