Lending Money to Your Corporation

Alan L. Olsen, CPA, MBA (tax)By Alan L. Olsen, CPA, MBA (tax)
Managing Partner
Greenstein, Rogoff, Olsen & Co. LLP

Starting a business takes a substantial amount of money and effort. There is a correct process to go through if you want to lend money to a corporation. First, you must properly document the transaction. If you give money to your business to purchase inventory and the company defaults on the loan, you may qualify to write off the loan as a business bad debt versus an investment loss. A business bad debt can be offset against other ordinary income such as W-2 income, interest and dividend income. This type of debt can also result in creating a net operating loss on your individual return when you don’t have enough income to offset the business loss.

A non-business bad debt is treated as a capital loss. A capital loss will only offset capital gains. If you realize net capital loss, you can then use the loss to offset up to $3,000 in ordinary income.

When you lend money to your corporation, the interest that you will be paid back with will be deductible to the business, but taxable to you.

If you are considering lending money to your corporation, there are four requirements that you must meet to qualify your debt for a loan instead of equity:

  1. Your debt should be documented as a written obligation that needs to be paid back by a specific date or a certain amount must be paid on demand.
  2. The debt cannot be converted into stocks for the corporation or any other equity interest.
  3. The corporation must determine interest rates and payment deadlines based upon corporation profits, decision making, and other factors.
  4. The lender must be an eligible shareholder of the corporation, individual, estate, trust or tax-exempt entity.

If a bank or individual will not make a loan directly your corporation, you can use a “back-to-back” loan. Back-to-back loans are an option for lenders of corporations if the lender wants personal guarantees in loaning money. In a back-to-back loan, the lender will make a loan to the shareholders who will then make a loan to the corporation. When a back-to-back loan is used, tax results are far better than if a corporate loan is made.

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