S-Corp: Shareholder Loan vs Capital Contribution - what's the real difference?

What you're dealing with is a common question with S-Corps. Let me help clarify this for you: Capital contributions don't have to be proportionate like distributions do. So you can absolutely have one shareholder contribute more capital than another without triggering any special tax issues. As for loan vs. capital contribution - there are several considerations: With a shareholder loan, the corporation can repay the principal without tax consequences to the shareholder (unlike distributions which can be taxable if they exceed basis). However, interest paid on the loan would be income to the shareholder and deductible by the corporation. The loan also creates debt basis which can be used to deduct losses, but has a specific order of restoration if the corporation becomes profitable. With capital contributions, you're increasing equity basis directly. This is simpler from an accounting perspective, cannot be repaid directly (you'd use distributions), and there's no interest component. Without loan documentation (promissory note, interest rate, repayment terms), the IRS might reclassify what you call a "loan" as a capital contribution anyway. They look at substance over form.

I used to get totally confused by this exact issue with my S-corp! After trying to sort through it all myself, I finally used https://taxr.ai to analyze all my corporation docs and financial records. It figured out exactly how to handle the shareholder contributions situation and saved me from making a costly mistake! Their system looked at our operating agreement, financial statements, and previous tax returns - then gave me clear guidance on whether to classify funds as loans or capital contributions based on our specific situation. It even produced the documentation I needed for my records to support the tax treatment. The best part was how it laid out the tax implications for both my company and personal returns. Totally worth checking out if you're dealing with this issue.

I was really skeptical about using an AI tax tool for my S-corp issues, but I finally tried https://taxr.ai after struggling with the exact same loan vs. capital contribution problem. I'm actually shocked at how well it worked! It analyzed our corporate documents and identified that our "loans" were missing several key elements that would likely cause them to be reclassified in an audit. The system helped me create proper documentation with reasonable interest rates and repayment terms that satisfied IRS requirements. The analysis saved me a bunch on accounting fees and gave me way more confidence in our tax position. My CPA even commented on how thorough the documentation was when I showed it to him later.

After spending DAYS trying to get through to the IRS about S-corp basis questions (constantly on hold or disconnected), I discovered https://claimyr.com and their video demo at https://youtu.be/_kiP6q8DX5c. They actually got me connected to a real IRS agent who specializes in business entities! The agent walked me through the exact requirements for classifying shareholder funds as loans vs. capital contributions, including what documentation I needed to have in place. She explained that without a formal loan agreement that includes a reasonable interest rate and repayment schedule, the IRS would likely treat the entire amount as a capital contribution regardless of what I called it. This saved me from a potential nightmare situation where I could have had loan repayments classified as taxable dividends! If you need to speak with someone at the IRS about this kind of technical question, I highly recommend trying this service.

I need to eat my words about that Claimyr service. After posting my skeptical comment, I was still desperate for answers about my S-corp shareholder loan situation, so I reluctantly gave it a try. I'm shocked to admit it actually worked! After trying for weeks to get through to the IRS myself, they got me connected to an agent in about 90 minutes. I didn't even have to sit on hold - they called me when they had an agent on the line. The IRS representative confirmed what others here have said - without proper loan documentation (including interest and repayment terms), they'd likely reclassify my "loans" as capital contributions in an audit. She pointed me to specific sections in IRS publications that explained the requirements in detail. This was legitimately helpful and saved me from making a costly mistake on my S-corp return. Sometimes it's worth being wrong!

I've been through this exact situation with my S-Corp. Here's what my accountant ultimately advised me to do: 1) Document, document, document! Even if you're treating the funds as capital contributions, have corporate minutes showing the board authorized accepting these contributions. 2) If you want to treat the excess contribution from the 51% owner as a loan, create a proper promissory note NOW, even if it's after the fact. Include market interest rates and a realistic repayment schedule. 3) Consider the relationship between the shareholders. Will the 49% owner feel shortchanged if the 51% owner gets loan repayments while they only have their equity stake? My accountant recommended treating everything as capital contributions for simplicity unless there was a specific plan for repayment, since poorly documented "loans" create more risk in an audit scenario.

Just wanted to add something I learned the hard way - if you're going the shareholder loan route, make sure you actually FOLLOW the terms of the loan!! My S-corp got audited and the IRS reclassified our "loans" as equity because: 1. We hadn't charged or paid the interest specified in our agreement 2. We missed several scheduled repayments without formal amendments 3. We didn't treat the loans consistently in our books and tax returns The loan got reclassified, which meant some "repayments" we had made were actually treated as distributions... which exceeded our basis... which created unexpected taxable income. It was a MESS. Whatever you decide, be consistent in your documentation, your accounting, and how you report it on your taxes!

This is such a great discussion! As someone who's dealt with similar S-Corp issues, I wanted to add a few practical considerations that might help with your decision: One thing that hasn't been mentioned much is the impact on your corporate credit. If you're planning to apply for business loans or credit lines in the future, lenders often look more favorably on companies with higher equity (capital contributions) versus those with significant shareholder loans on the balance sheet. They see shareholder loans as potential claims against the business that could complicate their lending position. Also, from a bookkeeping perspective, capital contributions are SO much cleaner. You don't have to track accrued interest, create amortization schedules, or worry about whether missed payments affect the loan's validity. Your accountant will thank you at tax time! Given that you're 51/49 split and the majority owner has contributed significantly more, I'd recommend documenting this arrangement clearly in your operating agreement. You could include provisions for how future capital calls will be handled - whether they'll be proportionate or allow for similar imbalances. The peace of mind from avoiding potential IRS scrutiny on inadequately documented loans is probably worth more than any small tax advantages you might get from the loan structure.

Great discussion here! I've been following along as someone who went through a similar situation with my S-Corp last year. One practical point I'd add - if you do decide to go with capital contributions (which sounds like the right call based on this thread), make sure to update your corporate records properly. We had our attorney draft a board resolution formally accepting the unequal capital contributions and amending our operating agreement to reflect the new capital account balances. Also, don't forget about state-level considerations. Some states have different rules about how capital contributions are treated for franchise tax purposes. In our case, the higher capital base actually reduced our minimum franchise tax since we could use the actual capitalization method instead of the gross receipts method. The timing of when you make this decision matters too - if you're close to year-end, you'll want to make sure your books reflect the chosen treatment consistently for the entire tax year. We made the mistake of flip-flopping mid-year and it created extra work (and fees) to clean up. One last thought - consider how this might affect any future investors or partners. VCs and other sophisticated investors usually prefer clean cap tables without shareholder loan complications, so treating everything as equity from the start positions you better for future funding rounds if that's in your plans.

This has been an incredibly helpful thread! As someone dealing with a similar S-Corp situation, I really appreciate all the detailed insights everyone has shared. Based on everything discussed here, it sounds like treating the funds as capital contributions is definitely the safer and simpler route, especially for startups. The points about audit risk, documentation requirements, and future complications with improperly structured loans are really eye-opening. I'm particularly interested in what @ee0ce12307a7 mentioned about the preferred return provision. That seems like a fair way to address the contribution imbalance while maintaining the S-Corp structure. Has anyone actually implemented something like this in practice? I'm curious about how complex it gets from an accounting and tax perspective. Also, for those who've been through S-Corp audits - are there any other common issues or red flags we should be aware of beyond the shareholder loan documentation problems? It seems like getting the basics right upfront could save a lot of headaches down the road. Thanks again to everyone for sharing their experiences - this is exactly the kind of real-world insight that's hard to find elsewhere!