Attempting to Avoid Shareholder Loan Reclassification

Many corporate shareholders may have taken a loan from their corporation.  In a prior article we discussed issues related to corporate loans and issues considered regarding the reclassification of a loan.  The article below discusses issues and actions a shareholder may consider taking to prevent the reclassification of a loan.  Please remember that this article is for informational purposes and it is recommended that you discuss any corporate loan issue directly with your tax attorney, business attorney or other advisors.

Proper recordkeeping and maintaining current promissory notes are of extreme importance regarding this issue.  The promissory notes must be kept current and reflect the payments that have actually been made by the shareholder to the corporation, the accrual of interest and other related issues in the previously executed notes.  Moreover, the approval of the loans should follow the proper approval and acceptance by the corporation’s board of directors and memorialized via the corporate minutes and other corporate memorandums.  The shareholder should also be able to verify that the interest has been paid on the note, the interest should be paid at regular intervals, and at least on an annual basis.  Contemporaneous evidence is always important when verifying loan payment and loan treatment to the Internal Revenue Service. From a tax return perspective, the corporate tax return should accurately reflect the loan on the balance sheet.

Because payment of the loan is such a vital factor, I often find it can be helpful to have multiple options or strategies for repayment.  Of course, the shareholder can make regular payments on a monthly, quarterly or yearly basis, but there are also other options for repayment.  If the corporation has strong earnings and profit, the shareholder could also use a distribution to pay make payment on the loan, perhaps even a lump sum payment to expedite payment on the note.  The shareholder may also be able to provide additional services to the corporation and receive bonuses for their work.  These bonuses could be paid to the shareholder and then paid to the corporation, or at least taxed to the shareholder as compensation and then reduce the amount of the note.

In short, generally the most important issues will be recordkeeping from corporate documents such as minutes, agreements and returns to the actual promissory note and making sure the shareholder is making payments with interest on the loan.

John McGuire is a tax attorney and business attorney at The McGuire Law Firm.  John assists clients with matters before the IRS, tax planning and advice, and business matters from contracts to the sale of business assets and interests.

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Rental Losses

Many individuals hold property for rent.  Rental properties can make good investment options as they diversify an individual’s overall portfolio, the mortgage can often be satisfied by the rental payments as equity grows in the property and with the allowable deductions, including depreciation, a loss may exists that allows the individual to lower their total income and thus taxable income.  In regards to the losses, it is important that those renting property understand rental losses and when they are allowed and when the rental loss is not allowed.  The article below has been prepared to provide general information regarding rental losses.

Rental income is generally considered a passive activity and thus is subject to the passive loss allowance rules under the Internal Revenue Code.  Under the code, a passive loss would generally not be allowed unless: 1) the taxpayer had passive income (passive losses can be allowed to the extent of passive income); 2) the taxpayer actively participated in the real estate activity and qualifies for the $25,000 rental real estate loss allowance; 3) there is a qualifying disposition under the Internal Revenue Code; or 4) the taxpayer meets the criteria to be considered a real estate professional.

It is likely the most common fact or circumstance that allows a taxpayer to take the passive loss is the $25,000 rental real estate exception. This exception allows a taxpayer with certain income to take the passive loss, up to $25,000 if the taxpayer actively participated in the rental.  Further, the taxpayer should know that the rental activity cannot be an equipment leases, but rather a real estate rental, they must have actively participated and their adjusted gross income needs to be within a certain amount or the allowance can be lessened or not allowed at all.

Thus, how does a taxpayer show active participation in a rental activity?  In general, if the taxpayer participates in the management of the rental activity they are likely to be considered to actively participate.  The taxpayer does not necessarily need to work a certain number of hours, but rather show they are exercising their own independent judgment and decisions regarding the rental, and not following the requests of another individual.  There are specific taxpayers that do not meet the active participation requirement, which are: 1) A limited partner; 2) A taxpayer with less than 10% ownership; and, 3) A trust or corporation, because the $25,000 allowance is only intended for a natural person.  It should be noted that a grantor trust could be an exception to number 3 above because a grantor trust is owned by a natural person because it is not deemed a separate entity.

The above article has been prepared by John McGuire, a tax attorney and business attorney at The McGuire Law Firm.  John’s practice focuses primarily on matters before the IRS, tax planning & analysis for individuals and businesses and business transactions from business formation to business contracts and the sale of business assets and interests.

Denver Tax Attorney