Lending money to your own LLC: how to document a member loan

Every small-business owner eventually moves personal money into the company account. The transfer takes thirty seconds. Deciding what that money is takes longer, and it matters more than most owners realize. Cash you put into your LLC is either a capital contribution, which buys you a bigger ownership stake, or a member loan, which makes you a creditor the company owes. The difference shows up at tax time, at payoff time, and, if things go badly, in a wind-down. A promissory note is what makes a member loan real.

Contribution or loan: what each choice means

A capital contribution raises your basis in the LLC and, in a multi-member company, may change the ownership percentages unless the operating agreement says otherwise. You do not get the money back on a schedule; you get it back through distributions when the company can afford them, and only in proportion to your share. If the company fails, contributed capital is the last money out.

A member loan is different in every one of those respects. The company owes you a fixed sum on fixed terms. It pays you interest, which is a business expense to the company and income to you. Repayment is not a distribution, so it does not have to be shared with other members. And if the company winds down, a properly documented loan is paid ahead of the members' equity, alongside the company's other unsecured creditors.

Why the IRS cares which one it is

The Internal Revenue Service (IRS) does not take your word for it. When an owner labels a transfer a loan but treats it like equity, the IRS can recharacterize it as a capital contribution. Interest the company deducted becomes a nondeductible distribution. Principal the company "repaid" becomes a distribution as well, which can be taxable depending on your basis. This issue comes up most sharply when the LLC is taxed as a corporation, but the same debt-versus-equity analysis applies to partnerships and can affect how losses and distributions are treated.

The IRS notes that an LLC with two or more members is taxed as a partnership by default, and a single-member LLC is disregarded, unless the company files Form 8832 to be taxed as a corporation. For a disregarded single-member LLC, the loan is largely invisible for federal income tax because you and the company are one taxpayer. The note still matters, though, for the reasons below.

What makes a loan look like a loan

Courts and the IRS look at a familiar cluster of facts. A written note with a fixed maturity date. A stated interest rate that a stranger might charge. A repayment schedule that the company actually follows. The company's ability to borrow from an outside lender on similar terms. Whether the loan is proportional to ownership (a loan that exactly matches each member's percentage looks like disguised capital). Your own conduct when the company fell behind, meaning did you enforce the terms. And whether the company was so thinly capitalized that no real lender would have made the loan.

You do not need to win every factor. You do need the note, the interest, the schedule, and a track record of payments. An unsecured note is the usual instrument. If the company has assets to pledge and you want priority over other creditors, a secured note with a filed financing statement is stronger still.

Setting a reasonable interest rate

A zero-interest loan to your own company invites trouble. The IRS treats a loan that charges no interest, or interest below the applicable federal rate (AFR), as a below-market loan. The AFR is a set of minimum rates the IRS publishes every month in a revenue ruling. Publication 542 explains that when a corporation receives a below-market loan and uses the money in its business, the forgone interest is imputed, meaning the tax code treats it as if the interest had been paid and then returned to the lender as a contribution. That creates phantom income for you and paperwork for everyone.

The simple fix is to charge at least the AFR for the loan's term. Short-term rates apply to loans of three years or less, mid-term to loans over three and up to nine years, and long-term beyond that. Many owners charge a point or two above the AFR to be safe. Whatever rate you choose, confirm it does not exceed your state's ceiling for a loan of this kind using the usury limit checker; Florida, for example, sets different caps depending on loan size.

Getting the operating agreement on board

Many operating agreements say something about member loans, and some require the other members' consent or a manager's approval. Read yours before you write the note. If it is silent, adopt a short written resolution authorizing the loan on the stated terms and have the members sign it. In a single-member LLC, a one-paragraph consent signed by you as the sole member does the job. This keeps the loan from looking like something you did to yourself after the fact.

Keeping the books clean

Record the loan as a liability on the company's balance sheet, not as member equity. Set up a recurring payment from the company account to your personal account and let it run. Accrue the interest even in months the company cannot pay, and issue yourself a Form 1099-INT if the company pays you $10 or more in interest during the year and it is taxed as a partnership or corporation. Keep the note, the resolution, and the payment history in a folder you could hand to an auditor. Our loan payoff calculator will produce the amortization table.

Protecting yourself as a creditor

The reason to do all of this is not only tax. If the LLC fails, members with undocumented "loans" are usually treated as equity holders, meaning they stand behind every vendor, landlord, and bank. A member with a signed note and a payment history is an unsecured creditor with a claim. A member with a secured note and a filed lien can be ahead of everyone else on the pledged assets. Courts can still subordinate an insider's claim if the loan was a sham or if the insider behaved unfairly toward other creditors, which is one more reason to keep the terms ordinary and the payments regular.

None of this is complicated. Write the note, charge a real rate, get it approved, and pay it on schedule. Your money went in as a loan; the paperwork is what lets it come back out as one.

Sources

• IRS, Limited liability company (LLC)
• IRS Publication 542, Corporations (below-market loans)
• IRS, Applicable federal rates (AFRs) rulings