You can obtain benefits from your company by borrowing for the following:
- Excellent option if you or your business have bad credit established
- Mortgage or bridge loans to help with the purchase of a home
- College or private school tuition for children
- Meeting extraordinary medical needs, tax bills, family emergencies, divorce settlement costs, etc
- Purchase of life insurance
- Purchase of a car, vacation home, or other expensive item
Advantages of borrowing directly from your company
Favorable interest rates including zero-interest loans in some cases
If you borrow money from your own company, you can obtain favorable interest rates. If the loan is less than $10,000, you may be able to borrow interest free. For most loans above $10,000, the rates can be favorable, provided they are not unreasonably low. If the rates are below the applicable federal rate set monthly by the Internal Revenue Service (IRS), they will be imputed under a series of IRS rules.
Attractive terms
Once again, the watchword is “reasonable.” A personal loan with a 100-year repayment term is probably not a loan at all. The IRS will likely deem it a distribution and tax it accordingly. You may structure loans with favorable terms, just as long as they are not unreasonable.
No application process
Unlike business loans from banks and business financiers, you will not need to go through an application process to borrow from your own company. You will not have to endure a credit check either. You can obtain funds without delay to take care of your financial needs.
No need to post collateral
Where a bank might require collateral to back a loan, you can borrow money on an unsecured basis from your company. This means you don’t have to put your home or other assets at risk. You can leave your assets unencumbered and use the equity for other purposes.
Caution: Whether or not a loan from your company is secured or unsecured is one of several factors the IRS will examine when determining whether or not your loan is, in fact, a distribution.
Insider loans do not trigger ERISA requirements
Loans to corporate executives do not fall within the definition of welfare benefit plans or pension plans for Employment Retirement Income Security Act (ERISA) purposes. Therefore, ERISA requirements don’t apply.
Are there any disadvantages of borrowing from your business?
You must comply with IRS rules
The tax rules are complicated and can be confusing. This increases the administrative costs of managing the loan. Troubles arise if you fail to properly document the loan or fail to structure a loan that is reasonable, based on current market conditions. You will need a promissory note signed by you and the company. The note should include details regarding the amount loaned, the term, and the interest rate. If the loan is under $10,000, the interest rate may be zero, but not if the principal purpose of the loan is to avoid federal taxes.
When determining whether or not a loan should be deemed a dividend distribution for tax purposes, the IRS and courts will consider the following factors:
- Whether the loan agreement places a cap on amounts advanced
- Whether security was granted for the loan
- Whether the shareholder was in a position to repay the loan
- Whether a repayment schedule was established and/or maintained
- Whether a maturity date was set
- Whether interest was charged
- The loan amount
- The extent to which the shareholder controls the corporation
- The earnings and dividends history of the corporation
- Whether a promissory note was executed
Remember: The interest you pay on the loan is deemed income to the company and will be taxed as such.