J.K. Lasser's Small Business Taxes 2013: Your Complete Guide to a Better Bottom Line

Loans by Shareholder-Employees

When a shareholder who is also an employee of a corporation lends the corporation money but fails to receive repayment, or guarantees corporate debt and is called upon to make good on the guarantee, it is not always clear whether the resulting debt is a business bad debt or a nonbusiness bad debt.

A business bad debt must arise in the context of a business. A shareholder who lends money to the corporation is doing so to protect his or her investment. An employee who lends money to his or her corporation is doing so to protect his or her business of being an employee. In this instance, employment is treated as a business. When an individual is both a shareholder and an employee, which status governs?

According to the U.S. Supreme Court, the dominant motive for making the loan to the corporation is what makes a debt a business or nonbusiness bad debt. Where the dominant motive is to protect one's investment, then the bad debt is treated as a nonbusiness bad debt. Where the dominant motive is to protect one's employment status to ensure continued receipt of salary, then the bad debt is treated as a business bad debt. In making this assessment, several factors are taken into account:

THE SIZE OF YOUR INVESTMENT IN THE CORPORATION

If your investment is substantial, it indicates that a bad debt might be the result of a desire to protect this investment.

THE SIZE OF YOUR AFTER-TAX SALARY FROM THE CORPORATION

If your salary is minimal, this indicates that ...