Houston Tax Attorney Blog
Houston Tax Attorney
If a Subchapter S corporation pays its shareholder’s personal expenses, can the payments be for the repayment of loans not subject to employment instead of wages subject to employment taxes? This is a common issue that has to be addressed when preparing S corp. tax returns. The IRS addressed this in AOD 2017-04, which was issued to note is disagreement with the U.S. Tax Court’s decision in Scott Singer Installations, Inc. v. Commissioner, T.C. Memo. 2016-161.
The S Corp Loan Case Facts
The facts in the Scott Singer Installations, Inc. v. Commissioner case are as follows: The taxpayer is a RV parts and servicing business and taxed as a Subchapter S corporation. Mr. Singer was the sole shareholder and actively involved in running the S corp. Mr. Singer advanced funds to the taxpayer in 2006-2011 and charged business expenses to his personal credit card. These advances were recorded as shareholder loans on the taxpayer’s books.
The taxpayer incurred losses in 2010 and 2011 and during these years it paid $181,872 of Mr. Singer’s personal expenses. These expenses were treated as repayments of the shareholder loans on the taxpayer’s books. The IRS determined that the taxpayer’s payments of Mr. Singer’s personal expenses were wages subject to tax.
The Court: Loan Repayments, Not Wages
The U.S. Tax Court concluded that Mr. Singer was an employee, but that the advances Mr. Singer made to the taxpayer were loans and that the payment of his personal expenses were repayments for those loans. The court reached this conclusion even though there was no promissory note or other documentation for the loans. Recording the transactions as loans on the taxpayer’s books was sufficient. The court also noted that the payment of personal expenses was recurring over time, which make it look like a loan repayment, and that the personal expenses continued to be paid even when the taxpayer was incurring losses.
The Importance of the Debtor-Creditor Relationship
The IRS does not agree with this holding. It concludes that the payment of a shareholder’s personal expenses by an S corp. are wages if the shareholder performs substantial services for the S corp. The IRS discounted the courts point that the recurring nature of the expenses and that the payments continued to be made when the taxpayer was incurring losses.
The IRS then notes the distinction between this case and the prior cases that reached the opposite conclusion, namely, the courts in the prior cases did not find a debtor-creditor relationship. If anything, the IRS’s AOD drives home the point that taxpayers should document the debtor-creditor relationship for loans.