My wife is a sub-s corp and opened her business just over a year ago. 
We funded her startup costs with a HELOC loan.  Part of the HELOC was
used for our home but we have records of how much was used for
business.

The business has been doing well and we put in more funds than she
really needed.  I spoke to our accountant about taking some of the
funds out of my wife's business bank account to pay down the business
portion of our HELOC and it does not appear we can do that.  The
accountant is telling us that the only way we can take out funds from
the business banking account is either as payroll (with large tax
consequences) or as distributions.  I thought we should be able to
just write a check from her business bank account to our HELOC account
and pay down the business loan but that doesn't seem to be an option.

Is this right?  Unfortunately, we over-funded the business and now
when we want to pay down the loan with business funds, the
bulk of the funds (our accountant says we should take 80% in payroll
and 20% in distributions) get taken through payroll so we loose a lot
in taxes.  When did we loose the ability to take funds out of the
business bank account without taking them out as payroll or
distibutions?

Something about this just doesn't seem right.  If we would have known
we couldn't move funds out of the business account without loosing
almost half of them to taxes, we would only have funded the business
with the absolute minimum.  But because we didn't know this we are
going to be screwed by the taxes.  I guess I should be glad we didn't
throw more money into the business.

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Request for Question Clarification by sublime1-ga on 25 Nov 2006 23:36 PST

shian...

This doesn't seem right to me, either. A business should have a way
to pay off its investors, even if the investor is an owner. It seems
to me there should be a way for a formalized loan to be created by
the investor/owner to document the amount invested in the company,
which requires that the company make payments to the investor/owner.

Then again, I'm not an expert on this topic, but I'd certainly want to
put this question to the accountant.

You pull the money out & book it as a withdrawal of capital. However,
you cannot deduct the withdrawal as a business expense, so it won't
affect your taxes. (The corp could deduct interest it paid you, but
you'd just have to declare the interest as income on your 1040, so
it's a wash.)

BTW, the IRS doesn't require you to take 80% of the income as wages.
You are required to pay yourself a "reasonable salary" regardless of
the business's profitability. This salary is subject to employment
taxes. The required salary is what your wife would have to pay someone
with her qualifications to do her work. This might be 20% of the gross
earnings or 150% of the gross earnings. 80% is just a rule of thumb
your accountant made up. Do some legwork to find out just how much it
would cost to replace your wife at work & set that as her salary.
(This may turn out to be more than 80%.)

A business often switches from LLC or sole proprietor status to S-corp
status once the owner's 'reasonable salary' is less than the
business's net profit. You don't want to be an S-corp if the business
is running at a loss!