How To Borrow Money From Your Business

It's sometimes tempting to take money out of a closely held corporation in the form of a nontaxable shareholder loan rather than as taxable salary or dividends. But unless you structure the transaction as a genuine loan and repay it accordingly, you're at risk of having the loan reclassified as a taxable transaction by the IRS.

Shareholder loans are subject to IRS scrutiny. Loans to stockholders are a popular target whenever the IRS audits closely held corporations.

To assist their auditors, the IRS has recently issued an audit guide on shareholder loans, detailing twelve factors to be evaluated when determining whether advances made to stockholders qualify as bona fide loans.

Follow these rules. If you take loans from your corporation, here's what you need to do. First, do the paperwork. Document that the board of directors has approved the loan, and have a promissory note drafted.

Don't forget to include a set maturity date as part of the promissory note. Be sure to state a fair market interest rate as well. To be safe, consider using one of the applicable federal rates published by the IRS each month.

When taking loans, don't get greedy. Taking more than you can reasonably afford to pay back is a red flag to the IRS.

To help support your position that the loan is genuine, making payments towards your outstanding balance is a must. It's a good idea to set up a loan amortization schedule and stick to it until the loan is paid off. Make sure you actually repay the loan; don't just roll it over into a new loan.

Check IRS guidelines. There are other factors that the IRS will explore when determining if your loan qualifies as a bona fide loan. The IRS audit guide on shareholder loans instructs the agent to evaluate the extent to which you control the corporation and whether you put up any collateral for the loan. The IRS agent will also review the dividend paying history of your corporation and whether loans were made to other stockholders in proportion to their ownership interest in the corporation. While sticking to the IRS guidelines for bona fide loans isn't easy, it's better than having the IRS reclassify your loans as taxable dividends or salary.

To find out more about taking loans from your closely held corporation, please give us a call.

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© Copyright 2001 Raymond S. Kulzick. All rights reserved. 010930.

This publication provides business, financial planning, and/or tax information to our clients. All material is for general information only and should not be acted upon without seeking appropriate professional assistance. Read Disclaimer.

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Copyright © 2001 Kulzick Associates, PA - Last modified: September 13, 2008