Shareholder Loans – Protect Your Business from the IRS
When borrowing money from your closely held corporation, adhere to the following five guidelines to defend IRS challenges that the loan proceeds are disguised compensation or dividends:
- Written Loan Agreement – Note. Draft a formal written loan agreement that establishes the shareholder’s unconditional promise to repay the corporation a fixed sum, according to an installment repayment schedule or on demand by the corporation. The loan agreement should give the corporation the legal right to enforce principal and interest payments.
- Interest on Loan. Charge interest on the loan at a rate that’s at least equal to the applicable federal rate (AFR). This will avoid unpleasant tax surprises and compliance hassles under the below-market loan rules (see “Below-Market Loan Rules,” below).
- Show Loan on Corporate Books and Records. Record a loan receivable from the shareholder on the company’s balance sheet and interest paid by the shareholder as income on the company’s income statement. (Likewise, the shareholder’s balance sheet should show a loan payable to the corporation.)
- Corporate Resolutions. Document in corporate minutes a summary of the loan terms and authorization of the borrowing by corporate officers. Corporate minutes should also include evidence that the borrowing shareholder was financially capable of repaying the loan when the loan was made. In appropriate circumstances, the company should obtain adequate collateral for the loan.
- Make Timely Repayments. Keep records to show that loan principal and interest payments from the borrowing shareholder to the lending corporation are made on schedule. If timely payments become impossible, the loan agreement should be amended to reschedule payments before they’re late.
Taxpayers audited on related party loans rarely lose in the U.S. Tax Court when meaningful amounts are repaid on time. Still, they seldom win when the opposite is true.
