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tondigelato
October 28, 2017
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Loan from Shareholder vs Capital Contribution in relation to Total Equity and Taxes

  • October 28, 2017
  • 3 replies
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Hello,

 

I have a Single Member LLC taxed as a sole proprietor. Aside from my initial capital contribution, I have put personal funds into the business. My CPA/bookkeeper categorized this as "loan from shareholder". I would like to know how my balance sheet would be affected (in regards to total equity as well as tax purposes) if I recategorized it as "capital contribution"?

Lastly, how would my balance sheet be affected (in regards to total equity and taxes) if I kept it classified as "loan from shareholder" but paid myself back? Would this lower or higher my total equity? Would i be taxed on it? and lastly, how would I categorize this in QBO?

 

The reason is because I'm trying to obtain a second loan (to open a brick and mortar gelato shop) and the bank wants my total equity to be at zero and not at a negative. 

 

Also, if paying myself back won't affect my total equity, then I'd rather use the money and re-invest it rather than leave it in the business as a loan from shareholder.

 

Thank you so much! My CPA is very non communicative. I've only been in business for a year.

 

James

    Best answer by Adam_Fenner

    James

     

    To start, I'm not a CPA, but I've passed all the tests, have the educational requirements and experience requirements. I'll be submitting my packet by next month. So, I'm not quite there, but I'm also not just spouting off crazy advice. 

     

    If you convert your loan from a loan to a capital contribution it will change some ratios, in a good way, especially if you are seeking financing. As the company would no longer owe you the money, it would simply be an increase to your shareholders equity that would be a good thing. I would think that a bank would view the shareholder's loan differently than a standard loan. As it is to you the business owner, and in a time of need, you could simply elect to not pay yourself. But if the bank cares, than convert it. The simple journal entry is:

     

    Loan from Shareholder                     XXX

         Owner's Contribution                         XXX

     

    Subsitute the names used in your own chart of accounts. This will fix your debt to equity ratio, in a favorable direction. 

     

    If you have a more detailed question on how to do this I can walk you through, just let me know. Too bad about your CPA being unavailable. I've been hearing a lot of them aren't particularly good with customer service. 

     

    Best of luck

    Adam

    3 replies

    Adam_Fenner
    Adam_FennerAnswer
    October 28, 2017

    James

     

    To start, I'm not a CPA, but I've passed all the tests, have the educational requirements and experience requirements. I'll be submitting my packet by next month. So, I'm not quite there, but I'm also not just spouting off crazy advice. 

     

    If you convert your loan from a loan to a capital contribution it will change some ratios, in a good way, especially if you are seeking financing. As the company would no longer owe you the money, it would simply be an increase to your shareholders equity that would be a good thing. I would think that a bank would view the shareholder's loan differently than a standard loan. As it is to you the business owner, and in a time of need, you could simply elect to not pay yourself. But if the bank cares, than convert it. The simple journal entry is:

     

    Loan from Shareholder                     XXX

         Owner's Contribution                         XXX

     

    Subsitute the names used in your own chart of accounts. This will fix your debt to equity ratio, in a favorable direction. 

     

    If you have a more detailed question on how to do this I can walk you through, just let me know. Too bad about your CPA being unavailable. I've been hearing a lot of them aren't particularly good with customer service. 

     

    Best of luck

    Adam

    Raywhite28
    Raywhite28
    October 29, 2017

    I'm no CPA but I was always instructed that a sole proprietor doesn't make loans to the business. Money going in is a capital contribution & money going out is an owner draw. Now, your CPA may know something that I don't know.

     

    Changing from a loan to a contribution should not have any tax affect.

    Raywhite28
    Raywhite28
    October 29, 2017

     Read Adam's reply. He gave you the journal entry or just edit the entry you bookkeeper made.

    john-pero
    john-pero
    October 30, 2017

    It is a good thing your CPA is no longer your CPA. I, also am not a CPA but I will put my experience up against that charlatan any day.

     

    Single Member LLC is not taxed at all unless you choose to be taxed as a corporation. It is a pass-through entity. All profit or loss migrates to your personal income tax form.

     

    There are no shareholders in even a multi-member LLC, only members.  Your initial infusion of capital and any additional contributions are Member Contributions of equity.

    Here is what you need to do. Create the 4 equity accounts necesary. Overall Equity which is summing and not posted to and 3 equity sub accounts underneath. Member Equity. Member Contribution. Member Withdrawal. The latter 2 represent money in and out from and to you in cash. Member Equity is where profit or loss posts at year end.

     

    Capital contribution increase equity. The mis-assignment as shareholder loan did not affect equity but created a false liability, actually lowering your balance sheet values

     

    If you started your business with $10,000 cash from personal funds you record as Member Contribution and your Equity is $10,000. If you pay your self back your equity drops to zero. If you end the year with a profit equity goes up less any amounts you distibute to yourself. With a loss or distribution of member draw greater than profit the equity goes down and can become negative. Compared to a corporation you have no oligation to return equity to zero or above.

      T
      tondigelatoAuthor
      October 30, 2017

      Great thank you! I figured that because I was a startup (on a low budget) my account wasn't worth her time (nor her bookkeeper that she assigned me to).

       

      So i understand that paying myself back won't do any good to me obtaining a new loan if the bank is looking at total equity. I will recategorize it as capital contribution and go from there.

       

      Thanks ! 

      Adam_Fenner
      Adam_Fenner
      October 30, 2017

      Not a problem. The loans can be very useful with you have multiple partners, but it is a moot point in a sole proprietorship. Unless there are regular payments and interest. 

       

      If you have any more questions let me know, quick stuff like this I enjoy. 

       

      I run my own accounting practice, and because of the stories, like yours, of poor customer service it is one of our top priorities. 

      J
      Justin37
      May 10, 2018

      This is a little late but after you pay down the shareholder loan, you will have more equity if you used money from the net income of the business. The net income is taxable but making the payoff is not taxable. 

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