Although any corporation can utilize shareholder loans, they appear most often with private, closely held corporations including S corporations.
A shareholder loan is a loan made to a corporation by one of its shareholders –either an individual or an entity — to provide capital to the company. In return the shareholder receives interest and principal payments. Some companies secure the loans they obtain from shareholder with stock while others offer no collateral. Shareholder loan are nearly always subordinate to bank and other commercial loans unless specific contractual instructions state otherwise. A shareholder loan can be secured by the shares as a loan against equity or by a promissory note. Shareholder loans are more commonly associated with S Corporations.
The amount of a shareholder’s stock and debt basis in the S corporation is very important. Unlike a C corporation, each year a shareholder’s stock and/or debt basis of an S corporation increases or decreases based upon the S corporation’s operations. The S corporation will issue a shareholder a Schedule K-1.
It is important to understand that the K-1 reflects the S corporation’s items of income, loss and deduction that are allocated to the shareholder for the year. The K-1 shows the amount of non-dividend distribution the shareholder receives; it does not state the taxable amount of a distribution. The taxable amount of a distribution is contingent on the shareholder’s stock basis. It is not the corporation’s responsibility to track a shareholder’s stock and debt basis but rather it is the shareholder’s responsibility.
If a shareholder receives a non-dividend distribution from an S corporation, the distribution is tax-free to the extent it does not exceed the shareholder’s stock basis. Debt basis is not considered when determining the taxability of a distribution.
- Journal of Accountancy: [http://www.journalofaccountancy.com/Issues/2004/Nov/AvoidTheTaxTrapWhenRepayingShareholderLoans.htm]
- Investorwords.com: What Is a Shareholder Loan? [http://www.investorwords.com/6666/shareholder_loan.html]
- IRS: S Corporation Stock and Debt Basis [http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/S-Corporation-Stock-and-Debt-Basis]