Pros, Cons, and Pitfalls to Avoid When Lending Money to Your Own Corporation

Pros, Cons, and Pitfalls to Avoid When Lending Money to Your Own Corporation

Pros, Cons, and Pitfalls to Avoid When Lending Money to Your Own Corporation

  • Business owners and entrepreneurs can find it useful to lend their own money to their corporation.
  • It’s essential to understand the many tax and compliance rules that surround giving a personal loan to a C corp, S corp, partnership, LLC, or sole proprietorship. 
  • Let’s look at the pros and cons — as well as the potential pitfalls — that you might face when you lend to your own corporation.

Can I Fund My Corporation With Personal Money?

Yes, business owners can give a corporation loan using personal money. In fact, when you start a corporation, it’s common for the initial funding to come from the personal assets of the founders, shareholders, or investors.

Here are two common ways to do this:

  • Equity investment: You can invest your personal funds into the corporation in exchange for shares of stock. This is a common way to provide capital for a corporation. The number of shares you receive will depend on the amount of money you invest and the agreed-upon valuation of the company.
  • Shareholder loans: Shareholders, including you, can lend money to the corporation in the form of a shareholder loan. These loans typically have a specified interest rate and repayment terms. It’s important to keep proper documentation and agreements for these loans to avoid any legal or tax issues.

When you fund your corporation with personal money, it’s crucial to maintain clear records and documentation of these transactions for accounting, tax, and legal purposes. Additionally, consult with a legal or financial advisor to ensure you’re following the appropriate legal and tax regulations for your specific jurisdiction since rules can vary.

What Are the Rules for Lending Money to Your Own Corporation?

Lending money to your corporation can provide a lot of benefits, but there are four most important rules to follow when you do so. Here’s a breakdown of the rules to follow to avoid a potential call from the Internal Revenue Service (IRS):

Lender must be eligible

To make a personal loan to a C corp, you have to be eligible. You can be eligible as a corporation shareholder or an individual. A lender may also be an estate, a trust, or other tax-exempt organization. 

If you’re a board member of a corporation, you need to be careful that you won’t directly profit too much from the interest payments made by the corporation. Follow IRS guidelines carefully to make sure the corporation isn’t penalized.

Let the corporation determine terms

The corporation has to use its profits and internal factors to figure out things like interest rates and repayment terms. If the lender is a board member, the board member needs to be absent while the discussion and vote to approve the loan takes place. 

The corporation can deduct interest payments from its taxes. 

Document everything

When you give a corporate loan, you’ll need to make sure everything is formalized in writing. Create loan agreement documentation that details how much the loan is, when the loan will be paid back, how the loan will be used, and the interest rates. Make sure the transaction is treated as “arms-length,” meaning the lender and the corporation are two completely separate entities. Keep in mind that the corporation won’t be able to change the debt into stocks or equity interest. 

It’s best to have a legal professional take a look at your loan agreement before finalizing it to make sure both parties are covered.

Consider a back-to-back loan

A back-to-back loan is an option to improve tax outcomes compared to lending directly to your own corporation. With a back-to-back loan, you’ll loan money directly to the shareholders, and the shareholders will loan the money to the corporation. This type of loan can reduce the tax burden and is an option if you can’t lend directly. 

Can You Loan Money to Yourself if You Own an LLC?

Lending money to other types of business structures, like an LLC, is often possible as well. You can typically give a loan to your own LLC. These are called owner loans, and they’re legal in most states. This can be quicker and simpler than taking out small business loans, but there are tax implications you’ll need to think through. There are also risks involved, like that you could lose your personal savings if the business fails. It’s important to think through the pros and cons before lending your LLC money.

Are There Any Tax Benefits of Loaning Money to a Business?

There can be tax benefits to loaning money to a business, but these benefits often depend on the structure of the loan and the specific circumstances. Here are a few potential tax advantages associated with lending money to a business:

  1. Interest income: If you charge the business interest on the loan, the interest income you receive is generally taxable as ordinary income. This income can be a source of revenue and is typically taxed at your regular income tax rate. It’s important to keep accurate records of the interest earned.
  2. Tax deductions: On the business side, the interest payments made to you as the lender are typically tax-deductible for the business. This can reduce the company’s taxable income, resulting in lower tax liability. However, there are rules and limitations, so it’s important to consult with a tax professional to ensure compliance.
  3. Bad debt deductions: If the business defaults on the loan and is unable to repay it, you may be able to claim a bad debt deduction. This can offset some of your taxable income, but there are specific criteria that must be met for a debt to be considered “bad.”
  4. Capital losses: If you sell the debt at a loss, you may be able to claim a capital loss. This loss can be used to offset capital gains, potentially reducing your overall tax liability. The rules surrounding capital losses can be complex, so it’s wise to seek professional advice.

Make sure the loan is appropriately documented so you can take advantage of these potential tax benefits. Additionally, tax laws can change, so it’s a good idea to consult with a tax professional or accountant who can give advice tailored to your specific situation and the current tax regulations in your area.

Can I Deposit Money Into My S Corp?

As a shareholder of an S corporation, you can deposit money into the corporation. This is a common way to provide additional capital to the business. When you do so, it’s considered a personal investment in the company. This can come in the form of cash or other assets. 

You’ll need to decide whether you want to treat the deposit as equity or a loan. If you treat it as equity, you’re essentially investing in the business, and it may affect your ownership stake. If it’s treated as a loan, the corporation may owe you repayment with interest. In exchange for your investment, you may receive additional shares of stock or simply contribute to the capital of the corporation. Check your shareholder agreement or corporate bylaws for any specific rules or procedures related to capital contributions. Some agreements may have provisions that outline how additional capital can be added to the corporation.

Also, depositing money into an S corporation can have tax implications. Any profits or losses generated by the corporation pass through to the shareholders’ individual tax returns. Consult with a tax professional to make sure you’re compliant with tax laws and regulations. Be aware of IRS guidelines regarding the financial relationship between shareholders and the S corporation. The IRS may scrutinize large capital contributions, especially if they are not in line with the company’s operations and financial needs.

It’s essential to maintain proper records and documentation of the funds you deposit into the S corporation. Keep track of the date, amount, and purpose of the deposit. Clear documentation is crucial for accounting and tax purposes.

What Is the Difference Between a Loan and an Investment?

An investment into your business is called a capital contribution. A capital contribution is basically you putting some of your personal money on the line in the corporation. The funds become shareholders’ equity. You might have to pay capital gains tax if you withdraw the investment in the future. 

A loan, on the other hand, is money given to the corporation with the intention of it being repaid, usually with interest. You’ll need to create a detailed written loan agreement with the help of a legal professional to make sure both parties understand the terms (like repayment terms and interest rates). The loan must be an “arms-length transaction,” or in other words, it treats you and the business as completely separate entities. 

Can I Loan Money to My LLC?

Yes, you can loan money to your LLC (limited liability company). It’s common for small business owners to loan money to their LLC since it can provide a way to infuse additional working capital when needed. Lending money to your own business to improve cash flow is quicker than applying for traditional bank loans or even loan from alternative lenders, and you can avoid paying interest. 

However, you’re putting your personal money at risk in case the business fails, and you can’t get the potential credit-building benefits of a small business loan. (Learn how to establish business credit in this comprehensive guide from Nav). 

Can I Loan Money to My Partnership?

Yes, you can loan money to your partnership. This is a common practice in business partnerships, and it can provide a way to infuse additional capital into the partnership when needed. These loans usually don’t face tax consequences because the owner and the business are not considered separate entities. 

Be sure to review the partnership agreement to ensure that there are no provisions or restrictions that may affect your ability to loan money to the partnership. Some partnership agreements may have specific guidelines or requirements for capital contributions or loans.

How Do I Borrow From a Corporation?

Borrowing money from a corporation, especially if you are a shareholder or owner of the corporation, can be a complex process. Here are the general steps you might follow:

  1. Review corporate bylaws and shareholder agreements: Start by reviewing the corporation’s bylaws and any shareholder agreements. These documents may outline the procedures and limitations for borrowing money from the corporation, which is called a shareholder loan. They may specify whether shareholder loans are allowed and the terms and conditions under which they can occur.
  2. Ensure legal compliance: Make sure that any loan transactions between the corporation and shareholders are in compliance with the laws and regulations of your jurisdiction. Different regions may have specific rules and restrictions regarding shareholder loans.
  3. Create a formal loan agreement: If shareholder loans are allowed and appropriate, write out a formal loan agreement. It should outline the terms and conditions of the loan, including the loan amount, interest rate, and repayment schedule.
  4. Approval of the Board of Directors or shareholders: Depending on the corporation’s structure and its governing documents, you may need approval from the board of directors or shareholders to proceed with the loan. 
  5. Record the loan: Proper record keeping is essential. Ensure that the loan agreement and all associated documents are accurately recorded in the corporation’s financial records. Keep copies of these documents for your own records as well.
  6. Comply with tax regulations: Be aware of the tax implications of the loan. Interest income earned from the corporation may be subject to taxation on your personal tax return. It’s a good idea to consult with a tax advisor or CPA to make sure you’re compliant.
  7. Repayment: The corporation must repay the loan according to the terms outlined its the loan agreement. 
  8. Annual reporting: Depending on your jurisdiction, there may be annual reporting requirements or tax implications related to shareholder loans. The corporation must make sure to comply with all relevant regulations.

The Bottom Line

Business financing doesn’t have to be complicated. Using  Nav is the simplest way to find the business funding you need, whether you’re a new business or have been around for years. See which funding options you can qualify for before you apply.

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