Funding a business can come from many different places. Sometimes as a small business owner you may find yourself in the position of needing to lend money to your own company. What does that look like? How do you manage loans from the owner to the company? And are there any long-term tax factors to consider before lending money to your own business? Read on to learn more! Besides doing research on your own, it’s a good idea to reach out to your company attorney or seek one out to aid your business.
Why Owner Funded Loans?
First – it often naturally happens in start-ups or small businesses that an owner may need to lend money to help get the business off the ground. Even with outside capital or investments, owners often invest money into their own businesses at some point in time. You can put money into your business in two ways – either as a loan (which we will talk about here) or as an investment. An investment into the business gets added to your owner’s equity or shareholder’s equity account, depending on the entity type of the business. If down the road you decide to withdraw the money previously contributed, you may have capital gains taxes on that money, depending on your equity balance and other factors. A loan must be paid back to the lender – in this case, the owner. The amount paid back is made up of both the principal amount (the initial loan amount) and the interest accumulated on the loan amount.
Whichever route you go, work closely with your company’s attorney to keep all documents in order and show a clear trail of where the money is going. Loans may be a better option for established businesses, if they have good cash flow and repaying the loan won’t be a point of concern. Having the option to lend money to your business can help it survive a low sales period or have the capital on hand to make the necessary changes to continue growth of the company.
Documentation is Key
When providing a loan to your business – no matter the amount – having thorough and accurate documentation of that money is important. The IRS requires that a business borrowing funds from a “related party” – such as an owner – have loan paperwork just like you would if you borrowed money from a bank. Included in this paperwork should be the terms, such as when the amount needs to be paid back, how and at what rate interest will occur, penalties for failure to pay, and other details. Without a detailed contract between the business and the lender, the IRS can question the validity of the loan. Work with your attorney or financial advisor to draft and finalize the documents needed for a loan to the business.
Aside from the loan agreement and other legal documents attached to it, having detailed in-house records is important as well. In your bookkeeping program add the loan to your business’ liabilities and track loan repayments, including principal and interest. This will ensure you have an up-to-date loan balance when reconciling your business finances and filing tax returns.
Learn More
Still have questions on what loans to your company could look like? Reach out to our team of experienced professionals for help and advice specifically tailored to your needs. While we can’t help you draft the loan documentation, we can help answer some basic questions and get you headed in the right direction. You can reach us by email, phone at (703) 912-7862, or set up a meeting on our website. If you’re ready to make a loan to your business, reach out to your company’s attorney to help draft the loan documentation and ensure things are in order. If you need help finding an attorney, our team may be able to connect you with some that are experienced in your business’ field of work.
