In a small S corporation, money moves between the owner and the business all the time. You cover payroll from your personal account in a slow month. You pull cash out of the company and tell yourself you will pay it back. Your bookkeeper labels both as "shareholder loans" and moves on.
The IRS does not take the label at face value. Whether a transfer is a real loan, a capital contribution, a distribution, or wages changes your basis, your ability to deduct losses, and whether a repayment is taxable. Get it wrong and the cleanup can be expensive.
Two directions, two different sets of problems
Shareholder loans run both ways, and each direction raises different questions.
| Direction | What it can do for you | What can go wrong |
|---|---|---|
| You lend to the S corporation | Creates debt basis that can let you deduct losses beyond your stock basis | Basis is reduced by losses, and repayment of reduced-basis debt can produce taxable income |
| The S corporation lends to you | Lets you use company cash without a current distribution | If it is not a real loan, it may be treated as a distribution or compensation; below-market interest rules may apply |
Loans from you to the corporation: debt basis
An S corporation shareholder can deduct passthrough losses only to the extent of basis. IRC 1366(d)(1) and Treas. Reg. 1.1366-2(a)(1) limit losses and deductions to the sum of (1) the adjusted basis of your stock and (2) the adjusted basis of any indebtedness of the corporation to you.
That second piece is debt basis. Treas. Reg. 1.1366-2(a)(2)(i) defines it as your adjusted basis in any bona fide indebtedness of the S corporation that runs directly to you. Whether the debt is bona fide is determined under general federal tax principles and all the facts and circumstances.
What does not create debt basis
- Guaranteeing a bank loan. Treas. Reg. 1.1366-2(a)(2)(ii) says a shareholder does not get debt basis merely by guaranteeing a loan or acting as a surety, accommodation party, or in any similar capacity. If you actually make payments on that debt, you increase debt basis to the extent of those payments.
- Loans from a different entity. The debt has to run directly to you. The regulation's examples show that a back-to-back loan, where you borrow and then relend to the S corporation, can create debt basis if it is bona fide indebtedness from the S corporation to you. A loan made through a disregarded entity you own is treated the same as a loan from you.
Losses reduce debt basis, and that matters later
Under IRC 1367(b)(2)(A), once losses and deductions drive your stock basis to zero, the excess reduces your basis in the corporation's debt to you (but not below zero). IRC 1367(b)(2)(B) then says any later "net increase" restores the debt basis first, before any of it increases stock basis.
Here is the trap. If the corporation repays a loan whose basis was reduced by losses and has not been fully restored, Treas. Reg. 1.1367-2(d)(1) treats the repayment as a recognition event. In plain English, part of the repayment is taxable to you, even though you are just getting your own money back.
Open account advances versus written notes
Treas. Reg. 1.1367-2(a)(2) treats shareholder advances not evidenced by separate written instruments as "open account debt" as long as the aggregate outstanding principal does not exceed $25,000 at the close of the corporation's tax year. Advances and repayments on open account debt are netted at year end. Once the unwritten advances exceed $25,000 at year end, the balance is treated like debt evidenced by a written instrument for later years.
That threshold is per shareholder, as Example 6 in the regulation shows. It is a reason to put larger shareholder loans in writing from the start, with a stated principal amount, interest rate, and repayment terms.
The return has to show it
The Instructions for Form 1120-S (2025) require the corporation to report, in Schedule K-1 Item I, the amount of debt owed by the S corporation directly to the shareholder at the beginning and end of the year, and say the Schedule L line 19 "Loans from shareholders" figure should generally reconcile to those K-1 amounts. Repayments of loans from shareholders are reported on Schedule K line 16e and on the K-1 of the shareholder who was repaid.
On your side, debt basis is tracked on Form 7203. If you claim losses using debt basis, the debt needs to be real, documented, and consistent with what the corporation reports. Our guide to Form 7203 and S corp basis limitations walks through the form.
Loans from the corporation to you
This is the direction that draws more IRS attention. An owner takes money out, books it as a loan to shareholder, and never repays it. Year after year the balance grows.
If the transfers are not bona fide loans, they are taxed as what they really are. For an S corporation, that is usually a distribution under IRC 1368 or compensation for services. A distribution is tax free only to the extent of your stock basis, and IRC 1368(b)(2) treats any excess as gain from the sale or exchange of property. Our page on distributions in excess of basis covers that result.
If you work in the business and take little or no salary, "loans" to you can also feed into a reasonable compensation problem, where the IRS argues some of the money was really wages.
What makes a loan look like a loan
No regulation gives a single checklist for this, but the factors are what you would expect from any lender:
- A written note signed when the money moved
- A fixed repayment schedule or demand terms
- Stated interest that is actually charged
- Actual payments of principal and interest
- Collateral or other creditor protections where an outside lender would ask for them
- Consistent treatment on the books and on the return
Below-market interest
IRC 7872(c)(1)(C) applies the below-market loan rules to any below-market loan directly or indirectly between a corporation and any of its shareholders. For a demand loan, that means interest charged at less than the applicable federal rate. Forgone interest is treated as transferred from the lender to the borrower and then retransferred as interest.
IRC 7872(c)(3) provides a de minimis exception for corporation-shareholder loans on any day the aggregate outstanding loans between the borrower and lender do not exceed $10,000, but the exception does not apply if one of the principal purposes of the interest arrangement is tax avoidance.
Shareholder loans and the one class of stock rule
A loan from a shareholder to the corporation can raise a different issue: whether the debt is really a second class of stock. The straight debt safe harbor in IRC 1361(c)(5) and Treas. Reg. 1.1361-1(l)(5) protects a written unconditional promise to pay a sum certain on demand or on a specified date, with interest not contingent on profits or the borrower's discretion, not convertible into stock, and held by an eligible creditor such as an individual who is not a nonresident alien.
Treas. Reg. 1.1361-1(l)(4)(ii)(B) also provides safe harbors for short-term unwritten advances from a shareholder that do not exceed $10,000 in the aggregate during the year and are treated and expected to be repaid as debt, and for obligations held by the shareholders in the same proportion as their stock. A sole shareholder's loans are always proportionate. For more on how a second class of stock can end an election, see our guide to second class of stock and ineligible shareholder problems.
Cleaning up a messy shareholder loan account
- Reconstruct the account. Trace every advance and repayment, both directions, by year.
- Match the books to the returns: Schedule L, Schedule K-1 Item I, Schedule K line 16e, and each shareholder's Form 7203.
- Paper the loans that are real. A note signed today does not rewrite history, but it can govern the future.
- Decide what the old "loans" really were. If an account was never going to be repaid, you need to deal with the tax result of what it actually was before an examiner does it for you.
- Check debt basis before taking repayments. A repayment of reduced-basis debt can create income.
If an IRS examination is already questioning your shareholder loan account, the stakes go up. The Law Offices of Darrin T. Mish, P.A. in Tampa can be reached at 813-229-7100. More on the exam process is at our IRS audits page.
A loan is a promise to pay. If nobody ever acted like the promise was real, the IRS will not either.
Frequently asked questions
Does personally guaranteeing my S corporation's bank loan give me debt basis?
No. Treas. Reg. 1.1366-2(a)(2)(ii) says a shareholder does not obtain basis of indebtedness merely by guaranteeing a loan or acting as a surety or in a similar capacity. If you later make payments on that guaranteed loan from your own funds, your debt basis increases to the extent of those payments.
Why would repaying my own loan to the S corporation be taxable?
If losses reduced your basis in the loan under IRC 1367(b)(2)(A) and that basis has not been restored, Treas. Reg. 1.1367-2(d)(1) treats a repayment as a recognition event. The part of the repayment that exceeds your remaining basis in the debt produces income. Net increases in later years restore debt basis before stock basis.
Is there a dollar amount under which shareholder advances do not need a written note?
Treas. Reg. 1.1367-2(a)(2) treats unwritten shareholder advances as open account debt if the outstanding principal is not more than $25,000 at the close of the tax year. Above that, the balance is treated like written debt in later years. Separately, the second class of stock safe harbor for unwritten advances in Treas. Reg. 1.1361-1(l)(4)(ii)(B) uses a $10,000 aggregate limit.
Can the IRS treat my loans from the S corporation as income?
If the transfers are not bona fide loans, they can be taxed as what they actually were, typically a distribution under IRC 1368 or compensation. Distributions beyond stock basis are treated as gain under IRC 1368(b)(2). Written notes, real interest, and actual repayments are the evidence that supports loan treatment.
This guide is general information about federal tax law, not legal advice for your situation. Reading it does not create an attorney-client relationship.