Quick Facts

Regulations define "basis of indebtedness of the S corporation to the shareholder" as the shareholder's adjusted basis in any bona fide indebtedness of the S corporation that runs directly to the shareholder.

Currently, open account debt cannot exceed $25,000 per shareholder at the close of the year. For example, an S corporation with ten shareholders could have up to $250,000 of open account debt as long as no single shareholder advances more than $25,000. If the balance of the indebtedness at the end of the year exceeds $25,000 for a shareholder, the entire amount is no longer considered open account debt and the shareholder may have to report income on repayments.

In general, if a shareholder's basis in a debt has been reduced by pass-through losses from the S corporation, gain must be recognized by the shareholder if the corporation pays down the debt. Therefore, repayment of open account debt may result in ordinary income for shareholders.

The rule for guarantees is distinguished from the general rule for adopting a bona fide indebtedness standard. Regulations hold that S corporation shareholders may increase their basis in indebtedness only if they end up paying off the loan they guaranteed on behalf of the S corporation.

These regulations are important to you and your shareholders if your basis in your open account debt is reduced for prior pass-through losses. Additionally, if you have loaned money to, or guaranteed a loan for, the S corporation you may be subject to these regulations as well.

Key Definitions

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Our comments may not contain a full description of all the facts or a complete exposition and analysis of all relevant authorities. Furthermore, the use of certain words such as “should, would, or will” is merely for grammatical convenience, is not intended to indicate a specific level of authority regarding a particular issue, and no explicit or implicit references should be taken there from. Our comments expressed herein are based upon the provisions of the Internal Revenue Code and Regulations in force on the date hereof, all proposed amendments to these Acts, Regulations and treaties publicly announced by the relevant authorities. Each and all of these authorities are subject to change at any time. Any such change could be given retroactive effect with respect to the transactions described herein and could cause the conclusions provided to become invalid, in whole or in part, with respect to any entity involved. There can be no assurance that these authorities will not disagree with, or challenge, the views set forth in this memorandum or that any such challenge will be unsuccessful.