Discussion:Interest paid for loan to S corp

The interest income goes on Schedule B and the investment interest expense deduction goes on Schedule A via Form 4952.

Notice 89-35

Interest expense on debt proceeds allocated under Reg. 1.163-8T to a contribution to the capital of a passthrough entity shall be allocated using any reasonable method. Reasonable methods for this purpose ordinarily include allocating the debt……..” Notice 89-35 also provides “……Individuals should report allowable interest expense paid or incurred in connection with debt-financed acquisitions on either Schedule E or Schedule A of Form 1040, depending on the type of expenditure to which the interest is allocated.

IRS Tracing Rules for Interest Deductions

Technically the interest gets allocated among the S Corp assets, so some of it could end up elsewhere.

What we've got here is a *loan to* the S corporation. I think - I'm mighty sure - that Notice 89-35 applies to purchases of stock and contributions to capital, and not to a loan.

At the risk of repeating myself: I'm pretty sure there's only one correct way to report this. The [shareholder's] interest income goes on Schedule B and the [shareholder's] investment interest expense deduction goes on Schedule A via Form 4952.

Did your team lose the Super Bowl or something?

Is there any reason why such interest income would not be considered "investment income" since the debt has not been incurred to purchase an investment, but rather to loan to a closely held business ?

Thanks to everyone for their comments.

Where does the adjustment arise? In the net investment income that's the Section 163(d) limitation, and any AMT difference that arises there?

It is probably worth discussing with the client whether the "investment" is a Loan or APIC the purchase of additional shares. Many of my clients don't itemize, and it seems rare that the classification of an investment as capital is as restrictive (as regards future withdrawals) as it would be for a regular corporation. Unless there are restrictions on distributions of equity according to state law. And possibly if the state taxes S corporations as C corporations.

BUT, even though the title to Section IV is "TREATMENT OF DEBT OF OWNERS OF PASSTHROUGH ENTITIES ALLOCATED TO EXPENDITURES FOR CONTRIBUTIONS TO OR PURCHASES OF INTERESTS IN SUCH ENTITIES (DEBT-FINANCED ACQUISITIONS)"; the very first paragraph under A. Allocation Rules discusses "In the case of debt proceeds allocated under section 1.163-8T to the purchase of an interest in a passthrough entity (other than by way of a contribution to the capital of the entity), . . ".

How does one purchase an interest without a contribution to capital? Does this refer to purchases of shares? Or is there way to loan funds and/while purchasing an interest in a passthrough entity? For example,purchase a share for a dollar and loan the S corp $100,000.

I can understand where it could be interpreted to allow a deduction to AGI for interest on a loan; the proceeds of which went into an S corporation. Maybe something to talk about during the audit and, at least, avoid penalties. Unless there is a court case about this out there.

Now, there are also at least a couple of *other* ways to "inject funds" [I choose not even to suggest that this term be defined] into an S corporation, as well as a purchase of shares of stock in the corporation, none of which are *loans* to the corporation. Some posters have suggested that these are all pretty much the same so the same rules should apply, close enough, it's six of one a dozen the other, it'll be close to the same result under certain conditions (which may or may not apply), and anyway, "the accountant who booked it that way is incompetent". I don't agree.

Try this f'rinstance: It's *not* a single-shareholder S corporation, and one shareholder would like to borrow some money and put it into the corporation, but the other shareholders veto his attempt to have additional shares issued to him for this additional "injection of funds". But they will allow him to lend the money to the corporation, and there are mutually acceptable terms for the loan's interest rate and repayment terms. What's the next logical place to go? Tell the shareholders you don't want them to do what they've agreed to do because .. because ...?

Let's play this out. It's a scenario that arises over and over and over. No, it's not happy hour yet.

And I agree with your response to the original OP's question.

Just kidding! I was in Berlin in 1924.