Can an S Corporation Assign a Note to Shareholders?

by Amanda McMullen

An S corporation can give money to a shareholder in the form of a loan, distribution or salary. Though the Internal Revenue Service (IRS) allows an S corporation to assign a note, or loan money, to its shareholders, the note must meet certain requirements before the IRS will treat it as a bona fide loan.

About S Corporations

An S corporation is a business entity that passes all of its income, credits, deductions and losses through its shareholders for tax purposes. The IRS requires S corporation shareholders to be individuals, estates or certain types of trusts. An S corporation can have no more than 100 shareholders. All shareholders must sign a consent form and submit it to the IRS before the corporation can legally become an S corporation.

Salary Requirements

In most cases, an S corporation can only make a loan to a shareholder if the shareholder also receives an adequate salary. If a shareholder provides services to an S corporation and the corporation has sufficient income, the IRS requires the corporation to pay the shareholder a fair market salary. If the corporation doesn't pay a salary to a deserving shareholder, the IRS may consider any loans made to that shareholder to be evidence of an attempt to avoid payroll taxes.

Loans to Shareholders

Although it is possible for an S corporation to make loans in excess of salary to shareholders, some S corporations may try to list all excess distributions to shareholders as loans in order to avoid potential tax consequences. For this reason, the IRS won't treat the distribution as a loan unless the corporation documents it, charges a market interest rate and develops a concrete payment schedule. If the distribution doesn't qualify as a loan, the shareholder who receives it must include the distribution as income on his tax return.

Considerations

If an S corporation pays you a salary, you must include the salary as income on your tax return, and the corporation must pay all applicable payroll taxes. If you need money in excess of your salary from an S corporation, you can also receive it in the form of a corporate distribution. If you receive a corporate distribution, you must include it on your income tax return as a capital gain.

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