7 Vital Questions to Determine: Loan, Distribution, or Salary?

If you operate your business as a C or an S corporation, and if you loan money to the corporation or the corporation loans money to you, you need documentation that the loan is indeed a loan.

With the S corporation, the loan that fails as a loan can result in taxable wages to you. 

With the C corporation, the loan that fails as a loan can result in taxable dividends to the shareholder.

Good News, Bad News

Nariman Teymourian got a real shock when, at the end of his IRS audit, the IRS claimed that he owed over $600,000 in taxes and penalties, primarily because he had received advances from the corporation in which he had majority control. 

Good news. Mr. Teymourian won his case in court and paid zero additional taxes. 

Bad news. Mr. Teymourian had to go to court. 

If you own a C corporation, pay attention to your advance account. When the IRS looks at your advance account, it decides between two options:

1. The advances are loans from the corporation to you.
2. The advances are disguised dividends that should be taxable to you.

 Obviously, there is a huge difference between a loan and a taxable dividend.

Here’s the Teymourian Story

Mr. Teymourian was building a home. His corporation made some big advances during this building effort. The paperwork between Mr. Teymourian and the corporation was not close to perfect and that triggered the problems with the IRS.

Key point – Operating as a C or an S corporation requires that you be pretty good at paperwork. 

Mr. Teymourian won his case, but, he also had the displeasure of the IRS’s company in court. 

To Do List for You

Here are seven magic questions to which you want to answer “yes” to ensure that your advances are treated as loans. We structured these as after-the-fact questions, because you would be giving your answers to the IRS after the fact.

1. Did you sign a promissory note or other document promising to repay the money to the corporation?
2. Did you pay interest on the advances?
3. Did you make payments on a fixed monthly, quarterly, or other schedule?
4. Did you give the corporation collateral to secure your repayment?
5. Did you repay the loan?
6. Did the corporation check to make sure you had the ability to repay the loan (i.e., did it look at credit reports and statements of net worth)?
7. Did both you and the corporation conduct yourselves as if the advances were loans?

Here is an additional question……Did you document the loan in your corporate minutes?

Not properly documenting your loan can result in a additional taxes, penalties, and interest.

Remember, if you are asked these questions today about last year or the year before, you want “yes” answers. The more “yes” answers, the better.