Shareholder loan interest

Facts

Shareholder loans with promissory note. Note requires interest at AFR.

Interest is imputed at AFR and recorded on corporate books.

Shareholder recognizes income.

NO payments are made in the tax year.

Shareholder and s corporation are cash basis.


Is it correct that corporation does not get corresponding interest deduction?

If no interest was paid during the year, then there won't be a deduction on the corporate return for interest paid. You may be able to reclassify an amount of shareholder distributions to interest paid.

If no interest was paid during the year, then there won't be a deduction on the corporate return for interest paid. You may be able to reclassify an amount of shareholder distributions to interest paid.

Out of curiosity - what if the corporation was accrual basis?

When you say interest is imputed at AFR, do you mean computed and accrued? Because you also say no payments are made. Does the note require payments or does it allow for payments at a later date? Does the unpaid interest attract more interest, as in compounding? What is it that required the shareholder to recognize the income? Is it constructively received? Does OID apply or is there an applicable exception? OID trumps 267.

Agree with the above post, why is the lender picking up the income if it hasn’t been paid? Interest is only imputed for, shall we say, below market loans.

When you say interest is imputed at AFR, do you mean computed and accrued?

Yes. The note specified interest at AFR.

Because you also say no payments are made.

Correct

Does the note require payments or does it allow for payments at a later date?

Allows for later payments. Demand note.

Does the unpaid interest attract more interest, as in compounding?

Yes

What is it that required the shareholder to recognize the income? Is it constructively received?

Not constructively received. Thought it was required to be recognized as income since it is a related party & OID.

Does OID apply or is there an applicable exception? OID trumps 267.

Now I’m not sure if it applies. It is a demand note with no required payments. Just interest accruing at AFR. No exceptions apply. I think this is where I’m getting tripped up is OID, 267, and 7872 and which applies.

267 is a deduction disallowance. Before that applies you have to have a deduction allowed then determine if the disallowance applies.

7872 does not apply if the stated interest rate is larger then the below market rates, which is AFR. Since the stated interest rate is AFR then likely 7872 does not apply.

OID I leave that one to Nilodop to comment.

Not constructively received. Thought it was required to be recognized as income since it is a related party & OID. Well, as Terry Oraha says, 267 is a deduction disallowance. Before that applies you have to have a deduction allowed then determine if the disallowance applies.. So, absent constructive receipt, only OID will cause the inclusion of income (and the allowance of the deduction), and it does. See reg. 1.1275-2(c)(3) and examples 7 and 8 in 1.1272(j).

Also read Q and A 2 under (b) here. https://www.govinfo.gov/content/pkg/CFR ... 67a-2T.pdf. "Temporary" regs. issued in 1984.

Thanks for the replies. This is very helpful. It’s interesting and confusing because there are so many different answers.

Nilodop- so because there is a debt instrument with adequate interest but no interest was paid and is compounded, income is included to the shareholder as OID. And, the corp can take an interest expense deduction regardless of their accounting method, correct?

But absent a debt instrument with adequate interest (which we may all see from time to time in this practice) between shareholder and corporation -267 and 7872 would apply. So we would see interest income imputed to the lender with no corresponding deduction if not paid by cash basis corporation. However, seems that accrual basis corporation would have an interest expense that would not be disallowed since the shareholder is recognizing income? https://www.thetaxadviser.com/newslette ... rties.html

Is it really a loan or is it equity? viewtopic.php?f=8&t=22595

Client is adamant to treat as a loan.