Yes, you can borrow money from your LLC and avoid tax penalties if the amount is less than what you contribute to the LLC, you avoid breaching any third-party agreements like bank loan covenants, and you follow IRS guidelines like applying an interest rate equal to the applicable federal rate. Otherwise, it may be seen as a taxable distribution.
The process is fairly easy, and we break it down in the sections below.
Can I Borrow Money From My LLC?
Any member of an LLC can borrow money from it. However, if the LLC has other members, they must approve the loan and report their authorization in the LLC’s minutes.
An advance of funds to a member can only be considered a loan if the LLC creates a legally enforceable promissory note for the repayment of the loan. The note should include the specific amount of the loan, the interest rate, a repayment schedule, and a description of any collateral or guarantees. The transaction should be recorded as a loan on the LLC’s books. If there are multiple owners of the LLC, the other owners must give approval and sign off on the loan.
The interest rate on the loan must be equal to (at a minimum) the applicable federal interest rate so it is a true business loan and not a business owner giving themselves a monetary distribution like wages. Just like a small business loan from a lender, the borrower will need to make payments on time, and the payments must be recorded. It is important to have a paper trail showing that it is an actual business loan (not a disbursement) and that you’re making payments with interest in a timely and scheduled manner.
The American Institute of CPAs goes into more detail about borrowing money from your business or LLC. They cover all of the details including “bona fide debt” where the principal and interest may be taxable if the loan is between unrelated parties.
If the business or you have any other loans, including personal loans like a mortgage on your house, you may not be able to use any collateral that’s already been leveraged. Collateral you may already be leveraging can include your house, your car, rental properties, or stocks and bonds, so be sure to double-check.
Tax Implications for LLC Loans
The IRS could consider your loan a taxable distribution if the amount borrowed exceeds how much you contribute to your LLC. In this case, the IRS could classify the distribution as a taxable gain.
A loan to a member might also incur tax if the loan is canceled. The cancellation would become a distribution and taxable income for the borrower.
If you borrow money from your LLC, you should pay interest on the loan every month or every quarter, much like you would on a commercial loan. The interest rate must be, at minimum, equal to the federal rate that the IRS charges.
The IRS will be looking to make sure the amount you borrow from your own LLC is in fact a loan and not wages, a distribution or disbursement. To ensure that you are in good standing, make sure you have a paper trail for the loan itself and that you are making loan payments on schedule. To help ensure the loan will be considered a business loan and not a taxable wage, have a licensed CPA look over the plan beforehand, as they’ll be able to confirm that the loan amount, the tax rate, the repayment schedule, and other items are all aligned with IRS guidelines.
Business owners have many avenues for funding, and they should explore each option carefully. A business owner borrowing from their own LLC is very common. As long as the transaction is properly documented and meets IRS requirements, you shouldn’t have any problems. However, if you don’t want to handle the record-keeping and prefer to go with reliable financing from an online lender, don’t overlook your options with National Funding.
We’ve been serving small business owners with fast, hassle-free financing since 1999. Click here to apply and explore your financing options with no obligation.
National Funding does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
