Now is a Good Time to Borrow Money from Yourself

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Want to take a bunch of money out of your corporation but don’t want to pay all the taxes that would apply if you took out a dividend or paid yourself a bonus?   Consider borrowing the money from your corporation.

The IRS publishes applicable federal rates (“AFRs”) each month.  The AFRs are the minimum interest rates that the IRS requires be charged on demand and term loans in various situations.  The extremely low interest rate environment of the last several years has produced extremely low AFRs.  For example, for the month of October, the short-term AFR (3 years or less) is 0.23% and the mid-term AFR (more than 3 but less than 9 years) is 0.93%. The long-term AFR (more than 9 years) for October with monthly or quarterly compounding is 2.34%.

Based on the AFR rates for October, you could have your corporation loan you significant dollars for a term of less than 9 years and pay interest on such money at the rate of only 0.93%.  This is way better than taking a taxable bonus or dividend.  Especially if you, like many other small business owners, expect to make additional capital contributions to the corporation from time to time in the future.

But you need to steer clear of pitfalls. The loan must be set up properly to avoid having the loan characterized as a taxable dividend or compensation payment. Some of the key factors for determining when a bona fide loan exists are:

(1) Whether there is a cap on how much can be advanced to the owner.

(2) Whether the owner gives collateral for the loan. Such collateral could be a pledge of the owner’s stock.

(3) Whether the owner is financially able to repay the loan. The owner’s stock in the corporation, other unrelated assets and salary as an employee of the corporation is considered in making this determination.

(4) Whether there is a repayment schedule and whether the owner made any repayments.

(5) Whether there is a definite maturity date.

(6) Whether the corporation makes any effort to collect the loan when due.

(7) The size of the loan.

(8) Whether the owner controls the corporation.

(9) Whether the corporation has any earnings and dividend payment history.

(10) Whether the loan is evidenced by a promissory note.

(11) Whether the corporation recorded and reported the loan on its accounting records and tax returns.

Give me a call or email at 937-223-1130 or jsenney@pselaw.com if you have any questions or comments about shareholder loans, or if you would like some help with properly structuring your loan arrangement.

AND ONE MORE THING.  Don’t forget capital loss carryovers you have from prior years.  You can only deduct $3,000 a year of capital loss against active income.  But you can deduct an unlimited amount of capital loss carryover against capital gains.  So make sure you consider realizing some capital gain to offset against your suspended capital losses.  If you are holding appreciated stock that you could sell at a gain, but you want to retain such investment, consider selling the stock to realize the gain, and then repurchasing the stock.  The wash sale rules only apply to losses so you can sell and repurchase at the same price on the same day.  Give me a call or email at Jsenney@pselaw.com or 937-223-1130 if you want to talk about year-end tax planning.