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Development accrued interest at the rate of 10 percent on
the withdrawn amounts and increased the loan balance for the
amount of the unpaid interest. The accrued interest was reported
as S corporation income by petitioners on their returns.
Although petitioners' inclusion of the interest income on their
returns is a factor that weighs in favor of finding that interest
was charged, the fact that no interest actually was paid is a
fact that weighs against finding that the withdrawals are loans.
The tax savings that would result by reporting the distributions
as loans, and then reporting the interest that accrued on the
distributions as income, are obvious. Reporting the interest
accrued on the loans as income was a relatively painless way for
petitioners to give the withdrawals the protective coloration of
loans.
Development credited the loan account for petitioner's
repayments. Petitioner contends that his "repayments"
demonstrate his intention to repay the amounts withdrawn.
Usually, a shareholder's repayments are strong evidence that a
withdrawal was a loan. The repayments, however, must be bona
fide. Crowley v. Commissioner, T.C. Memo. 1990-636, affd. 962
F.2d 1077 (1st Cir. 1992). Petitioner's purported repayments
were made in the form of debt assumptions and reclassification of
loans as salary which petitioner applied against the outstanding
loan balance.
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