Key Takeaways

  • One potential benefit of owning an LLC is the ability to borrow from the company.

  • Exercise caution when borrowing from your LLC to prevent tax complications and guarantee compliance with legal requirements.

  • Proper structuring and documentation are necessary for LLC member loans to be recognized as legitimate and not reclassified as taxable distributions by the IRS.

  • Before a loan is issued, multi-member LLCs must obtain approval from other members, and this approval should be recorded in the meeting minutes.

  • Any LLC loan must be accompanied by a legally enforceable promissory note specifying the loan amount, interest rate, repayment schedule, collateral, and default terms.

  • Personal savings, bank loans, or borrowing from family or friends are all viable alternatives to borrowing from an LLC, each with advantages and disadvantages.

One advantage of owning an LLC is the ability to borrow money from the company. LLC member loans may fulfill temporary cash flow requirements or offer liquidity for personal needs.  

However, borrowing from your LLC must be done carefully to avoid tax issues and maintain compliance with legal formalities.  

This guide will explore some of the essential LLC loan formalities and guidelines to ensure an LLC business loan to owner is legally compliant. 

Understanding Borrowing from an LLC

Can I borrow money from my LLC? The answer is yes. There are ways to legally borrow money from your business as an LLC member. 

However, unlike withdrawing a salary or making a distribution, borrowing money from an LLC must be carefully structured and documented. 

This ensures the loan is recognized as a legitimate business transaction and is not misclassified by the IRS as a taxable dividend or distribution.

The tax treatment and specific requirements for borrowing vary based on your LLC’s structure, whether it is a single-member LLC, a multi-member LLC, or if it is treated as a corporation for tax purposes. 

This makes it all the more critical to understand the process and follow the correct procedures to avoid legal and tax repercussions.

Steps to Borrow Money from an LLC

Using funds borrowed from your LLC calls for following particular guidelines to guarantee the transaction is correctly identified as a loan.

From getting permission to arranging thorough repayment arrangements, every action demonstrates to members and regulatory authorities that the loan is valid. 

Approval Process and Documentation

For multi-member LLCs, obtaining approval from other members is a critical first step when borrowing money. This formal approval establishes transparency and agreement among all members regarding the loan terms.

The approval should be documented through official meeting minutes outlining the loan's terms and conditions. 

By doing so, you meet legal requirements and reduce the risk of disputes or claims that the loan was improperly authorized.

Promissory Note Requirements

A legally enforceable promissory note is essential for any loan from an LLC. This document serves as a binding agreement between you and the LLC, outlining key terms and conditions of the loan.

The promissory note should specify the loan amount, interest rate, repayment schedule, potential collateral, and consequences for default. 

Detailing these terms creates a clear debtor-creditor relationship and reduces the risk of reclassification by the IRS.

Repayment Terms and Interest

To keep your loan legitimate, create a disciplined repayment plan with an interest rate that matches or exceeds the IRS interest rate (the applicable federal rate (AFR). This proves the loan is real and not just a distribution in disguise. 

Based on the provisions of the promissory note, timely loan repayment strengthens its validity even more and reduces the likelihood of an IRS investigation. 

Regular payments will be paid back, shielding the LLC from possible tax problems. 

Tax Implications of Borrowing from an LLC

On the subject of taxes, borrowing from an LLC carries potential tax implications that can become problematic if the loan is not properly structured and documented. 

Understanding these implications is key to avoiding costly reclassification or unexpected tax liabilities.

Loan vs. Distribution: Key Differences

Reclassification by the IRS is one of the primary concerns when borrowing from an LLC.

If a loan lacks paperwork or the parties do not follow through on its terms, the IRS might reclassify the transaction as a distribution or dividend.

For the borrower, this reclassification can result in large tax liabilities; for the LLC, it can create extra tax responsibilities.

Avoiding this situation mostly depends on correct documentation and respect for return terms. The reclassification risk is lowered if the loan is legitimate—supported by a promissory note and consistent payments. 

An example is the case of a husband and wife who owned a corporation.  

The company was run informally, with the husband taking a weekly salary plus a $100 check weekly. He took money from the company at his leisure and used it for personal bills/expenses.  

The withdrawals were noted as shareholder advances on the company's books and shown as loans given by the corporation and shareholders to third parties on financial statements.  

At year's end, part of the outstanding balance of the loans was repaid by deducting money from the husband's year-end bonus. 

An IRS audit revealed that the shareholder advances were not actual loans, so the IRS treated them as taxable transactions. The IRS's findings were backed up when the case was taken to court. 

The test for whether a withdrawal is a loan is if the shareholder intended to repay the money when the loan was made, and the corporation would require repayment.  

In the husband/wife corporation case, testifying the intent was to pay it back was insufficient evidence for the court to rule that borrowing money was a loan. Instead, the withdrawals were seen as dividends/distributions.

Taxable Gains on Cancelled Loans

Another potential pitfall is the issue of canceled or forgiven loans. If an LLC loan is not repaid or is forgiven, the IRS may classify the amount as taxable income to the borrower. 

Properly structuring and documenting the loan and adhering to repayment terms can help prevent this issue.

Tips for Avoiding Common Pitfalls

Proper documentation is the backbone of any loan from an LLC. 

To avoid being in a dispute about loans versus dividends/distributions, owners must follow rules and formalities when making a withdrawal to ensure the transaction is treated as a loan: 

  • Document the withdrawal as a loan along with a legally enforceable promissory note.

  • There should be valid documented minutes recorded noting the authorizing the loan.

  • Interest should be provided at the federal rate at the very minimum.

  • Collateral should be part of the loan when appropriate.

  • The transaction should be shown on the corporation's books and records as a loan and listed on any shareholder or corporation financial statements.

  • Repayments should be made following the terms outlined in the promissory note, with the loan repaid promptly. 

Note that loans being repaid in small amounts, the growth of the loan, and loans paid off at year's end and immediately renewed at the beginning of the next year can signal that the loan is not a true debtor-creditor relationship. 

It's also important that owners do not violate corporate formalities or their responsibility to minority shareholders and third parties to avoid tax dangers. 

One formality is meetings with the board members. Another may involve the borrower abstaining from the vote to approve the loan. 

Following the formalities also protects the company and the borrower from potential claims from officers, minority shareholders, and the government.

Alternatives to Borrowing From Your LLC

Borrowing from an LLC can offer flexibility, but it is not always the best option. 

In some cases, alternative funding sources could be more suitable, especially when considering potential tax implications or documentation requirements.

Three potential options to consider include:

Personal Savings

Using personal funds can be less complex than borrowing from your LLC. 

This can help you limit any possible tax authority inspection and remove the requirement for official loan documents. 

Personal Bank Loans

Getting a personal loan from a bank sometimes provides more freedom than borrowing from your LLC. Bank loans usually have properly stated terms and might have more reasonable interest rates and payback times. 

They also lack the same possible tax ramifications or IRS scrutiny that accompanies LLC loans. 

Family or Friends

Borrowing from a family member or friend may help you avoid mixing business and personal finances.

This alternative might cut the requirement for thorough documentation and have more attractive terms, such as reduced or zero interest rates. 

However, mixing personal matters with financial ones might cause problems if expectations are not precisely stated. 

Drafting a legal loan agreement helps safeguard both sides and specify the loan terms.

Each has challenges and considerations, so weigh the pros and cons before choosing one over the other. 

Making Informed Decisions with LLC Loans

Again, borrowing from your LLC can provide financial relief but must be handled carefully. By carefully adhering to legal and tax guidelines, you can maximize the benefits of your LLC structure while minimizing risks. 

Consulting with a financial advisor or an LLC attorney is highly recommended to ensure compliance and avoid pitfalls.

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FAQs

How much money can an LLC borrow?

No specific limit exists on how much an LLC can lend to a member. The amount depends on the LLC’s financial capacity and member agreements.

Can you get a business line of credit with no revenue?

Yes, but it often requires a personal guarantee or collateral. New businesses may find it challenging but not impossible.

How does a new LLC get credit?

A new LLC can establish credit in several ways, including: 

  • Opening a bank account for the business

  • Applying for a business credit card

  • Making timely payments to vendors that report to business credit bureaus