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Considerations for Owners Lending Money to Their Company: Documentation

Often, owners of a business lend money to their company, whether for short-term needs or for longer-term purposes. Too often, owners may not take the time to document the loan or take other steps to protect the owner as lender.

This is the first of three posts discussing steps owners can take to protect themselves: discussing the importance of properly documenting the loan, such as with a promissory note.

If you make loans to your company, there are several reasons why it is good practice to document those loans with a promissory note or similar documentation, including the following: 

  • Perhaps stating the obvious, to make sure the correct amount is repaid. 
  • If an owner or the company ever is audited by the IRS, the IRS will want to see proper records. If a loan is not adequately documented, there is a risk that the IRS could re-characterize the claimed loan instead as capital contributions to the company or interest payments as wages, dividends, or distributions. This could have unintended and unwanted tax consequences. 
  • The same risk of the loan being re-characterized as a capital contribution applies to creditors of the company or its owners. For example, if amounts are loans to the company by an owner, then that owner has a right to ask the company for repayment as a creditor should the company go south. If the amounts are contributions, however, then the owner has no claim to any of that money as a creditor and instead that money (or what is left), along with all other assets of the company, would go to repay creditors. 
  • Even if ultimately an owner does not get repaid and later wishes to treat a loan as a capital contribution to the company, for tax and record keeping purposes the owner will need to know exactly how much they have contributed. If the amounts are treated as additional capital contributions, then there will be tax ramifications one way or another.

Therefore, it is strongly recommended that if you loan money to your company, you document it by a promissory note or other writing. 

For more please see our posts on charging interest and obtaining security

DISCLAIMER: The information provided is for general informational purposes only. This post is not updated to account for changes in the law and should not be considered tax or legal advice. This article is not intended to create an attorney-client relationship. You should consult with legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.

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