The Tax Court ruled that payments made by a corporation to a married couple were repayments of a loan made by the wife. In this case, the wife loaned money to a corporation, in which her husband was the sole shareholder. This corporation later dissolved and a new corporation was later formed to continue the business. The new corporation made payments of $95,000 and $70,000 to the wife, which the couple treated partly as taxable interest and partly as nontaxable repayment of the wife’s loan. The IRS ruled that the payments were nondeductible constructive dividends to the
husband. The Tax Court ruled against the IRS, finding that while there was not a written assumption of the loan between the new and old corporations, the new corporation had purchased a software working model from the old corporation that had been developed with the money borrowed from the wife. The Court found that if these payments were not considered repayments, then the new corporation would have been unjustly enriched. As a result, the payments made to the wife were not treated as constructive dividends to her husband.
The Tax Court appears to have taken an equitable approach in this case that worked out in the best interest of the taxpayers. However, better tax planning at the time the loan was made and when the new corporation was formed may have avoided this conflict altogether, saving the couple court costs and attorney’s fees. A written loan assumption agreement between the old and new companies may have provided more clarity as to how the repayments were to be classified later.
Remember, to prevent such problems, when loaning money to a private, closely-held company, you should always have a loan agreement, a repayment schedule and interest stated. In addition, a corporate resolution should be placed in the corporate records to approve and verify the fact that an actual loan has taken place.
If you have loaned funds to your company, contact the professionals at The Center to review the transaction and determine whether or not you have handled all aspects of the transaction properly.
By: Basi & Basi at the Center for Financial, Legal and Tax Planning for Transworld M&A Advisors