Tax Impact of
Loaning Money to Your Business
Don't Forget the Interest
Often business owners infuse their business with additional cash. How
you structure this capital investment has a direct effect on the tax
consequences. In addition, the type of business entity (corporation, LLC,
partnership) you have created for your business also affects the tax
consequences.
If you have loaned money to your business, you are required to charge
interest on the loan; otherwise, interest will be imputed to you. This
means that interest will be computed on the outstanding loan balance at
the current rates and each payment will be considered to include interest.
While you are required to report the interest as income on your personal
return, your business is permitted a deduction for the interest paid.
When you make a loan to your business, it’s important to charge an
adequate rate of interest and document the loan with a stated repayment
schedule. The IRS publishes a
table of interest rates monthly that indicates the minimum
interest rates that should be applied for loans of various term lengths.
Failure to prepare a promissory note may cause the IRS to reclassify a
loan as a contribution to capital. This could have unintended
consequences. 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. Repayments on a loan are
not taxable to the extent of the principal.
Note: since a sole proprietor's business is not considered a
separate entity for income tax purposes, the above rules do not apply to a
sole proprietorship.
