2024 Q4 tax calendar: Key deadlines for businesses and other employers
Here are some of the key tax-related deadlines affecting businesses and other employers during the fourth quarter of 2024. Keep in mind that this...
2 min read
Maurice La Verdure : Aug 7, 2024 1:02:22 PM
If you own a closely held corporation, you can borrow funds from your business at rates that are lower than those charged by a bank. But it’s important to avoid certain risks and charge an adequate interest rate.
Basics of this strategy
Interest rates have increased over the last couple years. As a result, shareholders may decide to take loans from their corporations rather than pay higher interest rates on bank loans. In general, the IRS expects closely held corporations to charge interest on related-party loans, including loans to shareholders, at rates that at least equal applicable federal rates (AFRs). Otherwise, adverse tax results can be triggered. Fortunately, the AFRs are lower than the rates charged by commercial lenders.
It can be advantageous to borrow money from your closely held corporation to pay personal expenses. These expenses may include your child’s college tuition, home improvements, a new car or high-interest credit card debt. But avoid these two key risks:
Alternatively, the IRS might claim that you received a taxable dividend if your company is a C corporation. That would trigger taxable income for you with no offsetting deduction for your business.
Draft a formal written loan agreement that establishes your unconditional promise to repay the corporation a fixed amount under an installment repayment schedule or on demand by the corporation. Take other steps such as documenting the terms of the loan in your corporate minutes.
Current AFRs
The IRS publishes AFRs monthly based on market conditions. For loans made in July 2024, the AFRs are:
These annual rates assume monthly compounding of interest. The AFR that applies to a loan depends on whether it’s a demand or term loan. The distinction is important. A demand loan is payable in full at any time upon notice and demand by the corporation. A term loan is any borrowing arrangement that isn’t a demand loan. The AFR for a term loan depends on the term of the loan, and the same rate applies for the entire term.
An example
Suppose you borrow $100,000 from your corporation with the principal to be repaid in installments over 10 years. This is a term loan of over nine years, so the AFR in July would be 4.52% compounded monthly for 10 years. The corporation must report the loan interest as taxable income.
On the other hand, if the loan document gives your corporation the right to demand full repayment at any time, it’s a demand loan. Then, the AFR is based on a blended average of monthly short-term AFRs for the year. If rates go up, you must pay more interest to stay clear of the below-market loan rules. If rates go down, you’ll pay a lower interest rate.
Term loans for more than nine years are smarter from a tax perspective than short-term or demand loans because they lock in current AFRs. If rates drop, a high-rate term loan can be repaid early and your corporation can enter into a new loan agreement at the lower rate.
Avoid adverse consequences
Shareholder loans can be complicated, especially if the loan charges interest below the AFR, the shareholder stops making payments or the corporation has more than one shareholder. Contact us about how to proceed in your situation.
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