Should you categorize advances as bona fide debt, additional paid-in capital or something in between? It depends on the transaction.
            
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April 10, 2018 

Classifying Shareholder Advances Under GAAP

Hi There!,

Owners of closely held businesses sometimes need to advance their companies money to bridge a temporary downturn or provide extra cash flow for an expansion, a major expense or other purposes. Should you categorize those advances as bona fide debt, additional paid-in capital or something in between? Under U.S. Generally Accepted Accounting Principles (GAAP), the answer depends on the facts and circumstances of the transaction.

Need help with classifying your shareholder advances? Contact us.

Debt vs. equity

The proper classification of shareholder advances is especially important when a company has more than one shareholder or unsecured bank loans. It’s also relevant for tax purposes, because advances that are classified as debt typically require imputed interest charges. However, the tax rules may not always sync with GAAP.

To further complicate matters, shareholders sometimes forgive loans or convert them to equity. Reporting these types of transactions can become complex when the fair value of the equity differs from the carrying value of the debt.

Relevant factors

When deciding how to classify shareholder advances, it’s important to consider the economic substance of the transaction over its form. Some factors to consider when classifying these transactions include:

Intent to repay. Open-ended understandings between related parties about repayment imply that an advance is a form of equity. For example, an advance may be classified as a capital contribution if it was extended to save the business from imminent failure and no attempts at repayment have ever been made.

Loan terms. An advance is more likely to be treated as bona fide debt if the parties have signed a written promissory note that bears reasonable interest, has a fixed maturity date and a history of periodic loan repayments, and includes some form of collateral. If an advance is subordinate to bank debt and other creditors, it’s more likely to qualify as equity, however.

Ability to repay. This includes the company’s historic and future debt service capacity, as well as its credit standing and ability to secure other forms of financing. The stronger these factors are, the more appropriate it may be to classify the shareholder advance as debt.

Third-party reporting. Consistently treating an advance as debt (or equity) on tax returns can provide additional insight into its proper classification.

With shareholder advances, disclosures are key. Under GAAP, you’re required to describe any related-party transactions, including the magnitude and specific line items in the financial statements that are affected. Numerous related-party transactions may necessitate the use of a tabular format to make the footnotes to the financial statements reader friendly.

Need help?

Shareholder advances present financial reporting challenges that can’t be fixed with a one-size-fits-all solution. We can help you address the challenges based on the nature of your transactions and adequately disclose these transactions in your financial statement footnotes.

Sincerely,

Anne Taros, CPA
Director
LinkedIn
Twitter: @MooreStephensDM

Anne Taros assists a variety of clients with business and tax-related issues domestically and abroad. She works with small and mid-sized clients in the manufacturing, service, retail and wholesale industries, offering business advisory services, general ledger management, and tax planning and compliance. Contact Anne at taros@moorestephensdm.com or (248) 244-3160.

The Deadline for 2017 IRA Contributions is April 17, 2018

IRA contributions for 2017Tax-advantaged retirement plans like IRAs allow your money to grow tax-deferred — or, in the case of Roth accounts, tax-free. The deadline for 2017 contributions is April 17, 2018. Deductible contributions will lower your 2017 tax bill, but even nondeductible contributions can be beneficial.

Don’t lose the opportunity

The 2017 limit for total contributions to all IRAs generally is $5,500 ($6,500 if you were age 50 or older on December 31, 2017). But any unused limit can’t be carried forward to make larger contributions in future years.

This means that, once the contribution deadline has passed, the tax-advantaged savings opportunity is lost forever. So to maximize your potential for tax-deferred or tax-free savings, it’s a good idea to use up as much of your annual limit as possible.

3 types of contributions

If you haven’t already maxed out your 2017 IRA contribution limit, consider making one of these types of contributions by April 17:

  1. Deductible traditional. With traditional IRAs, account growth is tax-deferred and distributions are subject to income tax. If you and your spouse don’t participate in an employer-sponsored plan such as a 401(k), the contribution is fully deductible on your 2017 tax return. If you or your spouse does participate in an employer-sponsored plan, your deduction is subject to a modified adjusted gross income (MAGI) phaseout:
  • For married taxpayers filing jointly, the phaseout range is specific to each spouse based on whether he or she is a participant in an employer-sponsored plan:
    • For a spouse who participates: $99,000–$119,000.
    • For a spouse who doesn’t participate: $186,000–$196,000.
  • For single and head-of-household taxpayers participating in an employer-sponsored plan: $62,000–$72,000.

Taxpayers with MAGIs within the applicable range can deduct a partial contribution; those with MAGIs exceeding the applicable range can’t deduct any IRA contribution.

  1. Roth. With Roth IRAs, contributions aren’t deductible, but qualified distributions — including growth — are tax-free. Your ability to contribute, however, is subject to a MAGI-based phaseout:
  • For married taxpayers filing jointly: $186,000–$196,000.
  • For single and head-of-household taxpayers: $118,000–$133,000.

You can make a partial contribution if your MAGI falls within the applicable range, but no contribution if it exceeds the top of the range.

  1. Nondeductible traditional. If your income is too high for you to fully benefit from a deductible traditional or a Roth contribution, you may benefit from a nondeductible contribution to a traditional IRA. The account can still grow tax-deferred, and when you take qualified distributions you’ll be taxed only on the growth.

Alternatively, shortly after contributing, you may be able to convert the account to a Roth IRA with minimal tax liability.

Maximize your tax-advantaged savings

Traditional and Roth IRAs provide a powerful way to save for retirement on a tax-advantaged basis. Contact us to learn more about making 2017 contributions and making the most of IRAs in 2018 and beyond.
  

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