New S Corp Distributions in Excess

I have a new client who is a medical doctor. Unfortunately the client was working with another CPA who did not do a whole lot of planning or analysis and just willy nilly filed an S Corp election. This will definitely benefit her next year, however, the practice she is buying is going to be 100% financed. From the research I've done, section 1366 and the regulations for 1366 show that merely guaranteeing the debt of the S-Corp does not give the shareholder basis to deduct losses against and that distributions to do not reduce debt basis.

If we 179/bonus the assets that are eligible from the asset purchase and take her income below her distributions, she'll have distributions in excess. Since 2021 will be the first year, these distributions will be considered short term capital gains, correct? I believe section 1368(b) says that distributions in excess will result as the sale of property happened and the term is determined for the holding period based on how long they've been an S-Corp. If so, does it only make sense to 179 to that it does not reduce basis below -0- to avoid picking up the excess as ordinary income and extending the depreciation to more profitable years?

Thank you!

She will have borrowed money from her corp, not taken distributions in excess. Hint hint. Book it as a note, figuring that future profits will wipe it out.

She will have borrowed money from her corp, not taken distributions in excess. Hint hint. Book it as a note, figuring that future profits will wipe it out.

That's definitely one option I've seen and have a client whose done. I'll guess I wait to see exactly how much the "excess distributions" will be at the end of the year.


Thanks, JR!

Yeah, as I've said many times, I'm the one who declares the distributions, and it's never in excess of the profit. Any extra goes to a note, and in every case but one, future profits have exceeded those old loans and extinguished them. So during the year, I don't like to call the monies taken as distributions....we'll book them to a note or call them draws or withdrawals or something, and at year end, I'll book the actual distributions against the account that's catching all those monies paid out so it's clean for the taxes and ending Balance Sheet.

JR1 is correct that distributions can be avoided by borrowing instead.

I'm confused by the description of the fact pattern. Is the existing S conducting her practice or is it just a shell? Is it an asset purchase or a stock purchase, and if the latter will there be a 1038(h)(10) election and a QSSUB election?

I am assuming the purchase money note will be owed by her S and will be secured by a lien on the assets as well as her guarantee. So my impression is that distributing some 179 asset will not be doing anything useful and could be harmful. I say that because there would be no net distribution and 1245 would be triggered without a matching 179 deduction for her (because she is not in business, her S is.)

Suspending 2021 losses until there is income may be a good thing. And I don't see that there is much chance that there will be future losses, so I would not worry about stock and debt basis.

does it only make sense to 179 to that it does not reduce basis below -0- to avoid picking up the excess as ordinary income and extending the depreciation to more profitable years?

Remember that Section 179 deduction (unlike bonus depreciation) is a separately stated item. Therefore, the distributions will reduce the basis before the 179 does.

You can use the fact to potentially manipulate the deduction into being next year, which can be helpful, depending on the circumstances (you said maybe future years would be more profitable).

When taken in combination with the loan technique (so long as the loan is legit, etc.), you can pinpoint exactly how much 179 is allowed this year v. disallowed and deferred to next year due to basis limitations.

I'm confused by the description of the fact pattern. Is the existing S conducting her practice or is it just a shell? Is it an asset purchase or a stock purchase, and if the latter will there be a 1038(h)(10) election and a QSSUB election?

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Client is purchasing client list via asset purchase agreement. The client's S-Corp will be purchasing from her boss' S-Corp. Client also obtained additional loan to purchase new equipment and furnishings.

Consider borrowing and buying in her own name and contributing the equipment and furnishings via 351. That would eliminate the no-basis-for-a-guarantee problem, but I'm not confident it would be worth the extra hassle.

Just want to chime in and say I love this message board.

She will have borrowed money from her corp, not taken distributions in excess. Hint hint. Book it as a note, figuring that future profits will wipe it out.

JR, I’ve always liked your straight forward comments; cut to the chase! I am wondering about the mechanics of what you are saying here. I too just inherited a client with a $100K “loan to shareholder”, for this same reason, well a similar reason. Future profits are here in 2021. How do I pencil whip this? Let’s say profits in 2021 are $500K, and they distribute the entire $500K, how would the loan get repaid in that scenario? Would I book Distributions at $400K and the rest to the loan repayments? Or, do I instruct my client to take all but $100K in distributions, leaving $100K to wipe out the loan? Or would the client literally out the monies back into the company bank account?

Just curious; not trying to be a smarty pants.

She will have borrowed money from her corp, not taken distributions in excess. Hint hint. Book it as a note, figuring that future profits will wipe it out.

JR, I’ve always liked your straight forward comments; cut to the chase! I am wondering about the mechanics of what you are saying here. I too just inherited a client with a $100K “loan to shareholder”, for this same reason, well a similar reason. Future profits are here in 2021. How do I pencil whip this? Let’s say profits in 2021 are $500K, and they distribute the entire $500K, how would the loan get repaid in that scenario? Would I book Distributions at $400K and the rest to the loan repayments? Or, do I instruct my client to take all but $100K in distributions, leaving $100K to wipe out the loan? Or would the client literally out the monies back into the company bank account?

Just curious; not trying to be a smarty pants.

I've heard of people taking future "distributions" when they had enough profit to take, so there would be an increase to distributions and a decrease to shareholder loan. I guess it would all depend on what the client wants to do and what their future profits look like!

My preference would be the hope that they only take the 400k out so you can clear the loan. Usually it takes a few years as most of us take everything we can! The hard part is that the client never understands this.

I think in your case, Dave, if you want to clear the decks ahead of time and declare a distribution earlier on to show that you did wipe out the loan, it's a good idea. IF the client doesn't turn right around and take the money!

I'm with you, makes perfect sense. Thanks!

Just make sure that if you book it as a note payable, there is an actual note with appropriate interest charged.

Just make sure that if you book it as a note payable, there is an actual note with appropriate interest charged.

If we're paying this back with future profits, would you just increase the receivable by the imputed interest amount?

Hello, can we dumb it down for me for just a moment.

Why is there excess? (I'm assuming this means that the client is taking more in distributions than her basis).

The client 100% finances a practice.

Then the client 179/bonus deducts assets bought with the financing.

I am assuming that there are no profits yet (or only small profits), but there are bigger losses from the 179/bonus deductions - and that's the problem, is that correct?

I can't get my head around where there would be a capital gain here because it doesn't seem like cash was taken out - the problem is just that she can't take her loss yet, right?

If you did not call it a loan, the client would just lose the ability to deduct these losses in the current year - but not lose them forever? In the following year, when she has a ton of profit, could any losses that she couldn't take from the current year still could be used?

Hi ItDepends

The client was working with an accountant that was not communicating the tax implications of organizing as a C Corp vs. SMLLC and did not communicate the rules S-Corp's have to follow, i.e. shareholder-EE's needing to be on payroll.

The client has purchased the client list from the doctor she worked for who has since retired on 1/1/22. Until that point she was operating as an independent contractor. Since all of the income is going to be reported under the corporation, the client was taking all her independent contracting payments to live off of, constituting them being distributions.

Although the client list acquisition happened on 1/1/22, she purchased about 120K worth of equipment, etc. on financing outside of the purchase. Due to the rules of section 1366 she has no stock or debt basis in these assets since they are financed in the corporation. Since she pretty much would be deemed as having taken all the profit out of the corporation as distributions, to the extent that we take depreciation that causes her income in corporation lower than distributions, we have distributions in excess.

Yes, declare the interest, add to the note, issue the 1099INT.