Seattle Community

Sharon Abdul, CPA
CEO of eCFOservices, LLC
Seattle, Washington
Very helpful
7.5
out of 10
8 votes

Making a Loan to Your Business – Any Benefit?

Is there a tax benefit for making a loan to my business? Well…it depends…
Written Jun 29, 2010, read 6876 times since then.
Closed_info

 

Is there a tax benefit for making a loan to my business? Well…it depends…

First things first – get a lawyer to document your loan and draw up the appropriate promissory note documents and payment schedules. THIS IS A MUST! the absence of such paperwork may negate the loan in a tax court case.

There are obvious benefits to lending your business cash if you have some to lend such as avoiding the pains of going through all the paperwork and approval process a bank may take and it is quicker to get the cash infused into your business.

But what does that mean from a tax perspective?  It really depends on the type of organization you have whether it is a C-Corp, an S-Corp electing to be taxed as a C-Corp or it is a pass through entity (an organization that flows through your own personal taxes).

Pass through entities – because the individual, member or partner making the loan to the business is at risk of loss, then his or her basis in the business increases. In most cases, a business owner may only take losses to the extent of his or her basis, which means that the loan has allowed you to deduct more losses on his or her personal tax return.  While the business gets to take a deduction on the interest expense you have to report interest income so that aspect is not as significant as an increased basis.  

Cautions:

  • As you know everyone has to report interest income on their tax returns, don’t try and wiggle out of it by not charging your business an interest rate. A loan made to a business must bear market rate interest rates (which you have to report as income) or else the interest will be required to be imputed i.e. with each payment made to you, it is assumed the interest is built in and thus you still have to pay taxes on the imputed interest. Worse – failure to comply with this rule may cause the IRS to reclassify your loan as a contribution which you will not recover a loan that is reclassified as a contribution to capital unless you withdraw money from your business. If your business is incorporated, generally this distribution must be made in the form of taxable wages or a taxable dividend.

 C – Corps: with C-Corps the tax situation is slightly different, the company gets to take a deduction on the interest expense and it becomes a tax benefit to the business since it pays its own taxes. You still have to pay taxes on the interest earned as described above  so the benefit is mostly for the business.

The following caution is something to be acutely aware of because it could change your tax situation dramatically.

  • Be aware of your debt to equity ratios. If the debt is too high the IRS may determine the additional debt as disguised equity which if that happens, the payments that the company has been making may be considered dividends.  Only the interest on loan repayments is taxable, if it were a dividend, the entire payment would be subject to tax. Additionally, while interest expense is deductible for a corporation, a dividend payment is not deductible.

Definitely consult your CPA before moving forward with your transaction – it’s better to pay a CPA (which is deductible) than make a mistake that will cost you in taxes!

Learn more about the author, Sharon Abdul, CPA.

Comment on this article

  • Owner-Surgz Events 
Seattle, Washington 
Becci Harrison
    Posted by Becci Harrison, Seattle, Washington | Jul 01, 2010

    thank you for your article , Very interesting information as I never even thought of creating a loan to myself !! Thank you for your information Becci

  • Certified Public Accountant 
Issaquah, Washington 
Michael Jurenka
    Posted by Michael Jurenka, Issaquah, Washington | Jul 01, 2010

    Very good article, As a CPA who specializes in taxes, I would further state that shareholder loans to entities are not something to be taken lightly.

    On audit, an IRS agent will definitely look into the documentation surrounding notes to shareholders. Improperly documented promissory notes, not following the terms on the notes, and many other issues will cause lots of problems on audit.

    You should definitely consult a qualified CPA before pursuing a shareholder note between your company and you personally.

  • Health & Life Insurance Broker 
Auburn, Washington 
Ron Copple, RHU, LUTCF
    Posted by Ron Copple, RHU, LUTCF, Auburn, Washington | Jul 01, 2010

    Very insightful article, especially since funds are difficult to obtain from the normal lending institutions. Good subject and good information.

  • CEO of eCFOservices, LLC 
Seattle, Washington 
Sharon Abdul, CPA
    Posted by Sharon Abdul, CPA, Seattle, Washington | Jul 01, 2010

    Thanks Michael for that adding those very important notes.

  • CEO of eCFOservices, LLC 
Seattle, Washington 
Sharon Abdul, CPA
    Posted by Sharon Abdul, CPA, Seattle, Washington | Jul 01, 2010

    Thank you Ron and Becci for reading and commenting

  • Web design, development + strategic online success building. 
Minot, North Dakota 
Norma Maxwell
    Posted by Norma Maxwell, Minot, North Dakota | Jul 02, 2010

    Sharon - thank you for helping to clarify such a complex issue--much appreciated!

  • Massage Therapist 
Atlanta, Georgia 
Parnisia Duckworth
    Posted by Parnisia Duckworth, Atlanta, Georgia | Jul 02, 2010

    Thank you very much for this insightful information. I am looking forward to learning more from your articles

  • Photographer 
Tacoma, Washington 
Ramona Lynne
    Posted by Ramona Lynne, Tacoma, Washington | Jul 08, 2010

    I enjoyed the article. Good information to know. There was a lot of information for me to understand and I had to re-read it several times.

  • Process/ Management Consultant 
Woodinville, Washington 
Julia Robinson
    Posted by Julia Robinson, Woodinville, Washington | Jul 09, 2010

    Thanks Sharon, It pays to get the facts and that usually means having the right attorney / accountant - thanks for putting some great information out there!

  • Sales & Marketing  
Seattle, Washington 
Mary Beth Ingersoll
    Posted by Mary Beth Ingersoll, Seattle, Washington | Jul 15, 2010

    Sharon - Nice to see a business article on a subject that many business owners may consider sometime in their ownership. Keep them coming!

  • Organizational Consultant and Mediator 
Kirkland, Washington 
Diane Adalbert
    Posted by Diane Adalbert, Kirkland, Washington | Jul 20, 2010

    Thanks for the article, Sharon. It helped to clarify some information for me and goodness knows, information is power! looking forward to seeing more articles!

  • None 
Charlotte, North Carolina 
Gary Pharo
    Posted by Gary Pharo, Charlotte, North Carolina | Jul 20, 2010

    Great! Thanks for the great article posting and your all effort. I think the above article is valuable for all concerned people about this topics. For me the Informations are really really useful for my research. I've Bookmarked this page for future reference small business loan
    unsecured business loan

  • Business 
Albert City, Iowa 
sonya sousa
    Posted by sonya sousa, Albert City, Iowa | Dec 09, 2010

    I found so many interesting stuffs in your blog especially its discussion. It was a beneficial workout for me to go through your web page. It definitely stretches the limits with the mind when you go through very good info and make an effort to interpret it properly Merchant Cash Advance

Closed_info