When your S corporation needs money, you and your fellow owners can contribute more of your own cash to the company coffers. Another option is to make the corporation a loan. It's possible the company may end up closing its doors before paying you back. In that case, you may be able to claim the unpaid loan as a tax loss. (Ref1)

Shareholder Basis

S corporations normally pass corporate profits and losses through to shareholders to report on their personal returns. To claim a loss you have to subtract from your basis, which is your ownership share in the company. The stock basis is the amount of cash you've invested; the debt basis is the total loans you've made. Basis varies year to year based on losses, growth and how much of the loan the company has paid back. Keeping track of your basis and its growth will make it easier to settle up when the company dissolves.

Dissolving the Firm

If you and your fellow owners decide to close your S corporation, you can't simply walk off with the assets. You have to pay back your creditors, and that includes yourselves. Once you've settled debts with your outside creditors, pay yourself back for any loans that you made to the company. If you made the loan with a formal promissory note, the payback counts as capital gains income. Otherwise it's ordinary income, which may result in a higher tax rate.

Unpaid Debts

If you loaned the company, say, $35,000 over 10 years and only get $20,000 back, you may be able to write off the remaining $15,000 as a bad debt. If you claim it as a business bad debt, you can write it off against ordinary income; nonbusiness bad debts are capital losses. Surprisingly, the fact you're loaning money to your company doesn't automatically make it a bad business debt.

Business or Not

If the IRS questions whether your loan is a business debt, you may end up having to explain your motives for the loan. If, like many S-corp owners, you work for the company, you can argue you made the loan to keep yourself employed, which makes it a business debt. If you don't work for the corporation and made the loan to shore up your previous investments, the IRS may regard that as a non-business debt. It helps if you've documented the loan with plenty of paperwork.