Introduction:
Running a successful business involves various financial transactions, including loans made by the owner to the corporation or vice versa. But here's the catch – these transactions must be appropriately documented as loans to avoid potential tax liabilities. In this blog, we'll explore the critical difference between loans and taxable dividends, along with a real-life story that highlights the importance of proper documentation. If you own a C or S corporation, buckle up and get ready to understand the do's and do not's of corporate advances.
The Teymourian Story:
Nariman Teymourian's IRS audit resulted in a shocking revelation. He owed over $600,000 in taxes and penalties due to advances from his majority-controlled corporation. However, he emerged victorious in court and paid zero additional taxes. The takeaway here is clear: the documentation of corporate advances matters, and one must be diligent with paperwork when operating as a C or S corporation.
Loan vs. Taxable Dividend:
When the IRS reviews your advance account as a C corporation owner, it can either classify the advances as loans or disguised dividends, with significant implications for your tax liabilities. The key distinction lies in ensuring your advances are treated as loans rather than taxable dividends.
Seven Magic Questions:
To protect yourself from potential tax troubles, consider these seven crucial questions and ensure you can answer "yes" to each of them when it comes to your corporate advances:
1. Did you sign a promissory note or similar document to repay the money to the corporation?
2. Did you pay interest on the advances?
3. Did you adhere to a fixed repayment schedule, such as monthly or quarterly payments?
4. Did you provide collateral to secure repayment?
5. Have you repaid the loan in part or full?
6. Did the corporation assess your ability to repay, including checking credit reports and net worth statements?
7. Did both you and the corporation conduct yourselves as if the advances were loans?
The Importance of Documentation:
Properly documenting loans between you and your C or S corporation is essential. Should you face an IRS audit, failure to provide adequate documentation could lead to undesirable outcomes. Always strive to answer "yes" to as many of the seven magic questions as possible, as it will strengthen your case and avoid potential tax implications.
Conclusion:
In conclusion, understanding the nature of corporate advances and documenting them appropriately is crucial for business owners operating as C or S corporations. Mr. Teymourian's story serves as a valuable lesson on the significance of meticulous paperwork. By answering "yes" to the seven magic questions, you can protect yourself from tax-related troubles and focus on growing your business with peace of mind. Stay vigilant and remember, proper documentation is the key to success in the world of corporate finance.
You can reach our CEO and Owner Peter Ellefson anytime at peter@eplfs.com
Disclaimer: Laws and regulations are subject to change, and readers are advised to consult EPL advisors for personalized advice and compliance with specific state requirements. This information is not specific advice and is meant for general education.