OMG: Basis and Covid Releif

Let's say a single shareholder s corporation in it's first year makes $500,000 in sales and has $100,000 in operating expenses.

The shareholder (miraculously) did not put in any capital to begin with and ends the year with $0 cash and other assets.

The shareholder reports $400,000 in ordinary income from the profit (K1, line 1) and it flows to the personal return accordingly.

The shareholder took a $400,000 distribution.

Everything is fine and dandy.

But what happens in this example when the business get's $100,000 in relief from the RRF and uses it for the $100,000 of expenses and the owner was able to (and did) take out $500,000 in distributions?

The RRF is supposed to be magically not taxable and the expenses are still deductible.

But does the owner now have a $100,000 taxable (short term?) capital gain shown on schedule D?

Would the result be any different for a sole prop?

The RRF is considered to be tax-exempt income, which flows through on the K-1.

There would be $400K of ordinary income and $100K of T/E income providing $500K in basis before the $500K in distributions...
Easy peasy!

Oh, I see. I didn't consider T/E income as adding to the basis.

What about if, same example, except no RRF grant but a $100,000 SBA LOAN (that must be paid back) instead.

And the shareholder took out $500,000.

Does the SH have a capital gain for taking out more than the basis? Or no because the $100,000 liability adds to the basis.

If not, what would be a simple and real life example of where the SH would see a capital gain?

Yep...in the second version of facts, the shareholder has withdrawn someone else's (the bank's) money and has distribution in XS of basis = capital gain. If they've owned the stock more than a year, it's a LTCG.

Oh, I see. I didn't consider T/E income as adding to the basis.

What about if, same example, except no RRF grant but a $100,000 SBA LOAN (that must be paid back) instead.

And the shareholder took out $500,000.

Does the SH have a capital gain for taking out more than the basis? Or no because the $100,000 liability adds to the basis.

If not, what would be a simple and real life example of where the SH would see a capital gain?

Where I've seen this happen:

I have a client that doesn't believe in paying taxes so he buys equipment at the end of the year (whether he needs it or not) to wipe out any taxable income. I've explained spending 100% to save 30%[ isn't a great business strategy but he doesn't seem to understand the logic. Anyway, he has adequate cash to withdraw from the business since he takes SBA loans to buy the equipment but then he doesn't have basis to take large distributions since he wants to fully write off the equipment as section 179. So I have to constantly keep tabs on his basis to let him know if he's getting into dangerous territory with his distributions.

Thanks for the example - I could see that.

I've explained spending 100% to save 30% isn't a great business strategy but he doesn't seem to understand the logic.

So strange how many grown adults don't understand this. I've had otherwise intelligent and successful clients practically say things like "they hope they don't make a free windfall of $100,000 because they would want to pay the taxes on it".

So strange how many grown adults don't understand this. I've had otherwise intelligent and successful clients practically say things like "they hope they don't make a free windfall of $100,000 because they would want to pay the taxes on it".

It happens all the time. Client doesn't want to pay taxes ... so they spend more than the tax savings on things they don't need:

I've explained spending 100% to save 30% isn't a great business strategy but he doesn't seem to understand the logic.

A client wanted to buy a new computer to save on taxes. I asked her if she needed a new computer, she said "no". She still bought the new computer which ... cost her more than the tax savings.

Go figure.

Technically, if she told you she doesn't need it, it's not deductible?

I often use the line - "great, I will raise my fees to 10k so you will have a great deduction." Sometimes that helps