Taxpayers Guide to LLCs and S Corps
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Bad Loans to the S Corp
By Jason Watson, CPA
Posted February 28, 2020
If your loan is not in writing or does not have a firm schedule for repayment, it might be labeled as a second class of stock which will nullify your S Corporation. We know it’s a pain but go through the hassles of creating a proper instrument when lending money to your business. See IRC Section 1361(c)(5)(B). More amazing information! Or is it spellbinding?
As with most things in the IRS world, there are exceptions and many exceptions are called Safe Harbor provisions. In this situation, there is a straight debt safe harbor which allows for a loan by a person who is eligible to hold stock in an S Corp or is a business engaged in lending. The loan must not be convertible into stock, and there are some other rules. Let’s not muddy the waters quite yet since this is rare.
As mentioned earlier in this chapter, shareholder loans are generally a bad idea and might not be as elegant as basic cash injection.
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