How do you handle S-corporation Shareholder loans / capital contributions?

Question- I loaned funds into my s-corp. in 2006, 2007, 2008, 2010 and 2011 formally documenting each payment into the corporation which increased my loan basis.

However, because of the volatility of the business, the corporation was unable to pay the loan back which now I am considering re-classifying the funds as additional paid in capital.

Finally, during the past year, I was able to make payments - taken as distributions - paying back what I invested. I did not deduct interest and might have to make a 1099 adjustment before the corporate returns due date which in a couple of weeks.

I used Quickbooks; and my question is how should I treat this distribution - as a loan or capital payback without being flagged for an audit? When paying back capital is it still reported as income?

  • When distributing money that was put into the company classified as additional paid-in-capital , does it reduce the profit of the corporation ? – user25847 Feb 25 '15 at 15:46

As the owner of the S-corp, it is far easier for you to move money in/out of the company as contributions and distributions rather than making loans to the company. Loans require interest payments, 1099-INT forms, and have tax consequences, whereas the distributions don't need to be reported because you pay taxes on net profits regardless of whether the money was distributed.

If you were paid interest, disregard this answer. I don't know if or how you could re-categorize the loan once there's a 1099-INT involved. If no interest was ever paid, you just need to account for it properly:

If the company didn't pay you any interest and never issued you a 1099-INT form (i.e. you wrote a check to the company, no promissory note, no tax forms, no payments, no interest, etc.) then you can categorize that money as a capital contribution. You can likewise take that money back out of the company as a capital distribution and neither of these events are taxable nor do they need to be reported to the IRS.

In Quickbooks, create the following Equity accounts -- one for each shareholder making capital contributions and distributions:

  • Capital Contributions
  • Distributions
  • Retained Earnings (will already be in QB -- don't change it)

When putting money into the company, deposit into your corporate bank account and use the Capital Contribution equity account.

When taking money out of the company, write yourself a check and use the Distributions account.

At the end of every tax year, you can close out your Contributions and Distributions to Retained Earnings by making a general journal entry. For example, debit retained earnings and credit distributions on Dec 31 every year to zero-out the distributions account. For contributions, do the reverse and credit retained earnings.

There are other ways of recording these transactions -- for example I think some people just use a Member Capital equity account instead of separate accounts for contributions and distributions -- and QB might warn you about posting journal entries to the special Retained Earnings account at the end of the year. In any case, this is how my CPA set up my books and it's been working well enough for many years. Still, never a bad idea to get a second opinion from your CPA.

Be sure to pay yourself a reasonable salary, you can't get out of payroll taxes and just distribute profits -- that's a big red flag that can trigger an audit. If you're simply distributing back the money you already put into the company, that should be fine.

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