For small business owners, lending their own money to their business seems like an easy cash flow solution, and there are benefits. Still, there are also personal tax implications that need to be addressed, as well as rules and regulations that need to be followed.
When one’s business is strapped for cash in the short-term and needs a quick infusion, taking money from a personal account and lending it to the company makes a lot of sense.
“There are obvious benefits to lending your business cash if you have some to lend, such as avoiding the pains of going through all the paperwork and approval process a [Financial Institution] may take,”BizNik.com states.
The tax implications
While lending cash to one’s own business is a good short-term solution, there are tax implications that should be understood, and the specifics depend on the type of organization one owns - whether it is a C-Corp, an S-Corp or a pass-through entity (an organization that flows through your own personal taxes).
For pass-through entities, when the individual making the loan is at risk of a loss,, his or her basis in the business increases.
“In most cases, a business owner may only take losses to the extent of his or her basis, which means that the loan has allowed you to deduct more losses on his or her personal tax return,” adds BizNik.com.
With C-Corps, [“the] company gets to take a deduction on the interest expense and it becomes a tax benefit to the business since it pays its own taxes.” The loaner, on the other hand, still has to pay taxes on the interest earned.
As for S-Corps, the loaner “cannot take into consideration the loan when calculating any pass-through of losses from the business to your personal return.”
Additional considerations, rules and regulations
Before loaning cash to your business, consider the following advice:
- Initial investments usually aren’t considered loans
“If you’re just in the process of starting a business, don’t try to say that the money you’ve initially put into your corporation is a loan rather than a purchase of stock… You have to actually put money into a company for the stock purchase involved in a startup, and that money cannot be repaid to you as if it had been borrowed.”
“This may sound obvious,” says Microsoft Business. “But you don’t want to make a loan just by writing a check to the company. You have to document what you’re doing properly as being a loan from you to the corporation.”
Even if it makes sense from a tax standpoint to loan your own money to the business, there could be limits on how much you can actually lend. “Some business advisors suggest not having a debt-to-equity ratio of more than, say, 3-to-1,” adds Microsoft Business.
These are only a few of the potential tax implications of loaning money to your own business. To be sure not to be surprised by negative impacts, consult a tax professional or an attorney.
In the day-to-day world of small business ownership, loaning one’s own money can be a good short-term solution, but keep these issues in mind before diving in, and remember that your local financial institution has great rates and flexible loans that meet the needs of small businesses.