A common way for a shareholder to withdraw tax-free cash from a closely held corporation is to borrow money from it. However, for such a tax strategy to pass muster with the IRS, the loan must be business like. The IRS has issued an audit guide on shareholder loans. This guide describes factors that determine whether withdrawals will be considered loans or taxable dividends.
IS THE SHAREHOLDER LOAN A BONA FIDE LOAN?
Whether or not the IRS will consider a disbursement to a shareholder to be a loan for tax purposes depends on whether, at the time of the distribution, the shareholder intended to repay it and the corporation intended to require repayment. “Yes” answers to the following questions can help demonstrate this intent.
- Did the shareholder provide security for the loan?
- Is the shareholder in a position (as to salary, other income, and net worth) to repay the loan?
- Did the shareholder give a certificate of debt to the corporation?
- Is there a repayment schedule or an attempt to repay?
- Did the shareholder and the company set a maturity date for the loan?
- Does the corporation charge interest?
- Does the corporation make systematic efforts to obtain repayment?
- Is there a ceiling on the amount the corporation can advance?
IRS may reclassify the shareholder loans that aren’t considered bona fide as dividends — taxable to the shareholder and nondeductible by the corporation. “Yes” answers to the following questions would indicate that distributions to a shareholder may be constructive dividends rather than loans.
- Does the shareholder control the corporation’s affairs?
- Is the controlling shareholder’s ability to repay the shareholder loan contingent on future events?
- Does the corporation have adequate earnings and profits with respect to the advances made, coupled with no history of paying dividends?
The above list is not all-inclusive. No factor by itself is determinative; The IRS looks at the factors as a whole. For more information on shareholder loans, contact us today.