Reference: Goldsmith v. Comm’r, T.C. Memo 2017-20 & IRC Sec 1368(b)

An attorney conducted his business in an S corporation where he was sole shareholder.  Over a period of years, he supported the firm’s losses by borrowing against his residence and other assets.  In 2000, the firm received an $880,000 fee and he was able to repay some of those previous cash infusions. On audit, the IRS wanted to classify them as wages and assess him back income and payroll taxes .

The Tax Court found that those payments were shareholder distributions. To the extent that Goldsmith had basis in his stock, they were tax-free under IRC Sec 1368(b).