Can I borrow money from my LLC? The answer is yes. One of the advantages of owning your own business is the option to borrow and lend money to your business. It is also possible to borrow from a 401K plan.

Borrowing Money From Your Business

If you are a member of a limited liability company (LLC), you can borrow money from the company. The manner in which you can do so depends on how you have elected to have the LLC be treated, which would be as either a corporation or as a pass-through entity specifically for tax purposes. If there are other members involved, you must get approval from them before borrowing any money from the business.

If the LLC is being treated as a pass-through entity, there is no need to borrow money from the company. With this business structure, cash can be taken out as a draw, which you will pay or will have already paid income taxes on. Although borrowing is permitted, it is recommended that you speak with an accountant or with corporate legal counsel before proceeding.

It is worth noting that while owners often borrow from their businesses, the Internal Revenue (IRS) has the authority to re-characterize the loan and make it a dividend or a distribution, which makes it taxable to the recipient. It may also not be deductible to the corporation.

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 every week. He took money out of 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 audit by the IRS brought to light that the shareholder advances were not actual loans and undertook to treat the advances as taxable transactions. The findings by the IRS were backed up when it was taken to court.

The test for whether a withdrawal is a loan is if at the time the loan was made, the shareholder intended to repay the money and the corporation was going to require repayment. In the husband/wife corporation case, testifying that the intent was to pay it back was not sufficient evidence for the court to rule that the borrowing of money was a loan. Instead, the withdrawals were seen as dividends/distributions.

Tips or Making Withdrawals From Your LLC

To avoid being in a dispute about loans versus dividend/distribution, 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. It should also be listed on any shareholder or corporation financial statements.
  • Repayments should be made following the terms set forth in the promissory note, with the loan repaid in a timely manner.

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

It's also important that owners not violate corporate formalities or their responsibility to the minority shareholders and third parties to avoid tax dangers. One of the formalities includes meetings with the members of the board. It may also include the borrower abstaining from the vote to approve the loan.

Adhering to any formalities the company sets ensures all facts are communicated. Following the formalities also protects the company and the borrower from potential claims that may arise from officers, minority shareholders, and the government.

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