How to Correctly Loan Your LLC Money

Lending money to your Limited Liability Company (LLC) provides capital for your business, functioning as debt rather than an equity contribution. Properly structuring and documenting such a transaction is important to ensure it is recognized as a legitimate loan for tax and legal purposes. This approach allows the LLC to receive funding while establishing clear repayment obligations and terms, differentiating it from an ownership investment. Understanding the procedures for establishing, accounting for, and managing these loans helps maintain the integrity of your LLC’s financial structure and safeguard personal assets.

Creating a Legitimate Owner Loan

Establishing a loan from an owner to an LLC requires treating the transaction as if it were between two unrelated parties. This “arm’s length” principle is important for the loan to be considered bona fide debt. The Internal Revenue Service (IRS) scrutinizes related-party transactions to ensure they reflect market realities, including the interest rate charged.

A reasonable, market-rate interest rate is necessary; the IRS publishes Applicable Federal Rates (AFRs) monthly, which provide minimum interest rates for various loan terms. Charging an interest rate within 100% to 130% of the AFR can serve as a safe harbor, though the specific rate should also consider the LLC’s creditworthiness. A clear repayment schedule must be established, outlining whether payments will be fixed monthly installments, balloon payments, or payable on demand. The loan must also have a specific maturity date, the date by which the entire principal must be repaid. Securing the loan with LLC assets through a security agreement or deed of trust can provide additional assurance for the lender.

A promissory note is a legal document outlining the principal amount, interest rate, repayment terms, and maturity date, and it must be signed by both the lender and an authorized representative of the LLC. A more comprehensive loan agreement can further detail terms and conditions, such as events of default, remedies, and representations. For multi-member LLCs, obtaining formal approval from all members, often through a resolution or an entry in the operating agreement, is prudent to authorize the loan and the signing authority.

Accounting for the Loan in LLC Records

Once an owner loan is established, accurate record-keeping within the LLC’s financial system is essential. The initial recording of the loan involves recognizing the funds received as a liability on the LLC’s balance sheet. This means debiting the cash account and crediting a liability account, typically named “Loan from Owner” or “Shareholder Loan,” classified as a current or long-term liability depending on the repayment timeframe.

The LLC must accrue interest expense on the outstanding loan balance, even if payments are not yet made. This involves recognizing the expense on the income statement and increasing the corresponding liability or a separate interest payable account on the balance sheet. When the LLC makes payments to the owner, these payments are recorded by reducing the loan principal and expensing the interest portion. This process requires an accurate loan amortization schedule, which breaks down each payment into its principal and interest components.

Maintaining a clear distinction between owner loans and owner equity contributions in the LLC’s books is important. Loans represent a debt the LLC is obligated to repay, whereas equity contributions represent an ownership stake. Proper classification ensures the LLC’s financial statements accurately reflect its liabilities and equity for internal financial management and external reporting.

Tax Implications for Lender and LLC

Owner loans to an LLC carry tax implications for both the borrowing entity and the lending individual. From the LLC’s perspective, the interest paid on the loan is generally a tax-deductible expense. This deduction can reduce the LLC’s taxable income, which flows through to the owners’ personal tax returns in the case of a pass-through entity.

For the owner acting as the lender, the interest received from the LLC is considered taxable income. This interest must be reported on the owner’s personal tax return as ordinary income. The repayment of the principal amount of the loan by the LLC to the owner is not considered taxable income, as it represents a return of the original capital loaned.

The IRS examines related-party transactions, including owner loans, and can reclassify a purported loan as an equity contribution if it lacks the characteristics of a true debt. Factors considered include a written promise to pay, a fixed interest rate, a maturity date, and a repayment schedule. If a loan is reclassified as equity, the LLC could lose its interest expense deduction, and payments made to the owner might be treated as non-deductible distributions or taxable dividends, particularly for C corporations.