You can loan money to your own company, but there are tax implications and other situations to be aware of.
If your business is structured as a limited liability company, or LLC , it means you aren’t personally liable for any of the company’s debts. You are, however, free to loan your own money to the company (and as much as you’d like) to help it meet its daily operating expenses or generate new business.
In some cases, this type of loan may be preferable to borrowing money from a bank or other source. However, there are several things to keep in mind when loaning money to your LLC, including the tax implications and what happens if your LLC can’t pay the money back.
Here’s what you need to know about loaning money to your LLC.
Can You Loan Money to Your LLC: The Short Answer
Yes, you can loan money to your LLC. The only hitch is that you’ll need to have the proper paperwork drafted to acknowledge what the business owes you and how it will repay the loan. In addition, your LLC will need to make regular payments, and you’ll have to charge at least a nominal interest rate to make the transaction legal.
Can You Loan Money to Your LLC: The Long Answer
While you can loan money to your LLC, there are several things to keep in mind before moving forward.
Separate Entity
You should only lend money to your LLC once it is legally established as an LLC and your state recognizes it as such (choosing a business structure like an LLC needs to be done well in advance of the loan). Once the state accepts the LLC formation paperwork, the company exists as an entity that is legally separate from its owners (called members).
Under the law, the LLC can do many of the things that an individual does, including entering into contracts, hiring employees, and taking out loans. One advantage of an LLC vs. a sole proprietorship is that owners can enter into arms-length transactions with the company (meaning each party is acting independently).
State laws, by default, allow members to loan money to their own LLCs. However, an operating agreement signed by the members can prohibit or limit this practice, so it’s important to read your LLC operating agreement carefully before making a loan to your LLC.
Equity vs Debt
When members of an LLC put money into the company that does not have to be paid back, the investment is considered an equity contribution. An equity contribution increases the member’s ownership interest in the company. When the company becomes profitable, that member will get a greater share of the profits.
If a member contributes money that the LLC has to pay back, it does not affect the ownership structure of the company. It is treated as a loan and falls under the category of funding through debt.
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Lending Your Money Correctly
To make your loan to your LLC official and legal, you’ll need to draw up a formal loan agreement that includes:
• Who the creditor is
• Who the debtor is
• Exact loan amount
• Repayment schedule
• Interest amount
• Consequences of defaulting
• How payments should be submitted
It can be a good idea to have an attorney prepare the loan agreement so all the required conditions are included. Once you make the loan, you’ll need to make sure that the company repays the debt and upholds the terms of agreement.
Tax Considerations of Lending Money to Your LLC
When you receive payments from your LLC, they will be split between principal and interest. The Internal Revenue Service (IRS) considers any interest paid to you as taxable income, even if it’s interest on a loan you made to your own company. The principal amount your LLC pays back, however, is not counted as taxable income because you already paid tax on it the year you had that income.
On the LLC’s side, the IRS treats a loan from an LLC member the same as it treats other types of small business loans. The loan itself is not considered taxable income to your LLC, since the money will be repaid. However, the interest your LLC pays you on the loan is a tax-deductible business expense. Repayment of the principal is not tax deductible.
Can You Recover a Loan From Your LLC in Case of Bankruptcy?
The answer depends on your LLC’s existing debts and what was agreed to in the loan agreement. In a bankruptcy proceeding, lenders with secured loans get first priority.
Any of your LLC’s assets that have already been spoken for by a lender would be liquidated to pay those debts first. If all of the LLC’s assets are not already spoken for, you might be able to seize them to recover the loan if such action was stipulated in your loan agreement under what would happen as a result of unmet payments.
Without anything clearly outlined, other members may question your right to those assets, especially if it was clear when you made the loan that your LLC might go out of business. It could be argued in court that you only made the loan so that you could gain access to those assets afterwards. Business bankruptcies can get ugly, which is why you need everything in writing.
Can You Charge Interest on a Loan to Your LLC?
Yes, you can (and should) charge interest on a loan to your LLC. When loaning money to your own company, it’s best to draw up a formal loan agreement and have an attorney review it. You should charge an interest rate that’s in line with market rates and come up with reasonable loan terms.
Keep in mind that interest paid to you (even if it’s a loan you made) is considered taxable income by the IRS.
Pros and Cons of Loaning Money to Your LLC
Loaning money to your own LLC avoids the time and effort involved in applying and getting approved for a business loan from an outside lender. Depending on the interest rate you set, it could also be less costly to your LLC than getting a traditional business loan. Extending a loan to your LLC also shows potential investors that you have faith in the company’s future.
However, loaning your own money to your LLC also involves time and paperwork, and you may need to consult an attorney to make sure the loan agreement is legally sound, which can add to the expense.
And, while loan interest payments are tax-deductible to your business, you lose this benefit if you make the loan yourself, since you will have to report these interest payments (and pay tax on them) on your personal taxes.
You’ll also want to keep in mind that lending money to your LLC involves risk. If the company were to go belly up, you might not get your money back.
| Pros of Loaning Money to Your LLC | Cons of Loaning Money to Your LLC |
|---|---|
| Fast influx of money for the company | Requires drawing up detailed paperwork |
| Loans have a tax benefit for the LLC that a contribution doesn’t provide | You may need to hire an attorney (which adds to cost) |
| Credit score and cash flow will not be scrutinized by a bank | Interest payments must be reported on your personal tax return, which can negate the tax benefits of a business loan |
| Shows investors you have faith in your business | You could lose your money if the company hits hard times |
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4 Other Ways of Raising Funds for Your LLC
If you decide against loaning your own money to your LLC, there are other funding options you can consider.
Term Loan
A term loan is a small business loan given to businesses by a bank, credit union, or online lender. Interest rates are typically fixed, meaning your monthly payments will not change throughout the course of the loan. Business term loans can be used for nearly every business expense.
Business Line of Credit
A business line of credit is great for businesses who want consistent access to funds. They work similarly to a credit card, where a lender gives you a maximum amount to draw on. You only pay interest on what you use, and can use the line again as you pay it down.
Equipment Financing
Equipment financing is a type of small business financing where the equipment serves as collateral for the loan.
Small Business Grants
Small business grants are money given to your company that do not need to be repaid. While they tend to be competitive, it can be worth your time and effort to secure this type of funding.
The Takeaway
Loaning money to your own LLC can be a viable source of funding for your business, but you’ll need a binding legal contract between you and the LLC stipulating the terms of the loan, otherwise the IRS can deny the validity of the loan.
You’ll also want to keep in mind that by loaning your own funds to your LLC, you lose some of the tax advantages of business financing. And, should the company file for bankruptcy, you could lose your money. You may decide that an outside loan is a smarter choice for your LLC.
If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.
FAQ
Can you loan personal money to an LLC?
Yes, but you’ll need to create a formal loan agreement between you and your LLC.
What are your options for funding an LLC?
There are many options to fund an LLC apart from lending or contributing your own money. These include a bank or SBA loan, an online loan, a business line of credit, a merchant cash advance, invoice financing, an equipment loan, peer-to-peer to lending, crowdfunding, or outside investors.
Can you borrow from your own LLC?
Yes. If there are other members of the LLC, however, each must approve the loan. You’ll also need to document the loan as a legally enforceable promissory note. Otherwise, the IRS may see the money as a taxable dividend or distribution.
Do you have to charge interest on a loan to your company?
If you’re drawing up a formal loan agreement, it is best to treat the loan accordingly by charging a fair interest rate and setting reasonable loan terms.
Can you fund your LLC with personal money?
Yes, you can fund your LLC with personal money as a donation to your company or you can loan your LLC money and draw up a formal loan agreement. In the case of a loan, the LLC would be responsible for paying you back.
Photo credit: iStock/fizkes
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