Whether you’re the sole business owner or a shareholder in an incorporated partnership, understanding shareholder loans is essential to maximizing the benefits of your corporate structure.
In a time when interest rates are increasing, a shareholder loan can be a great option that offers lower interest, more flexibility and control.
Let’s dive into what a shareholder loan is, how to use it, and other important considerations.
What is a Shareholder Loan?
A shareholder loan is a financial agreement between a shareholder and the company.
Shareholder loans come in two forms:
- When a shareholder lends money to the company
- When a shareholder takes a loan from the company
Let’s explore these two scenarios in detail.
Shareholder Lending Money to the Company
When a shareholder provides funds to the company through a loan, the shareholder is a creditor, and the company is the debtor. This financing can be beneficial if a company requires additional funding for a project, day-to-day operations, or expansion.
There are little to no tax implications when a shareholder lends its corporation money. When the company pays the shareholder back, it is paid back tax-free, but any interest payments from the company to the shareholder are taxable.
A common example of a shareholder lending money to the company is when the company is a startup. When a company does not have enough cash to cover operations and expenses yet, the owner will lend funds to the company to cover expenses.
Shareholder Taking a Loan From the Company
In this scenario, the company lends money to one of its shareholders not designated as a salary or dividends. As long as the shareholder repays the loan within a specific time frame (often within a year), the money is not taxed as personal income. However, if the shareholder does not repay the loan within the specified time frame, it must be reported as personal income on their tax return. Shareholders may want to take a loan from the company to help cover personal expenses, purchase assets, or make investments outside the company.
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It is extremely important that in both scenarios, the loan is documented, and the shareholder and company agree upon the loan amount, terms, and conditions.
How to Use a Shareholder Loan?
Let’s go over six ways you, as a shareholder, can use a shareholder loan strategy.
- Personal cash flow needs: If you require money for personal expenses or investments, a shareholder loan allows you to borrow from the corporation rather than find external financing options.
- Tax planning and deferral: Shareholder loans can be part of an effective tax planning strategy. By borrowing funds from the corporation instead of taking dividends or salary, you can defer personal income taxes. This strategy allows you to postpone recognizing personal income to help reduce your current tax liability.
- Investment opportunities: Shareholder loans can provide capital for investment opportunities, such as real estate, stocks, or a business venture, without depleting your personal savings or requiring external financing. (Learn about how to invest inside your holding company and the different investment options )
- Cash management and liquidity: Shareholder loans can help manage cash flow and improve liquidity. If the corporation has excess funds, lending those funds to a shareholder can allow for better use of available cash resources.
- Flexibility and control: Unlike external loans from financial institutions, shareholder loans offer more flexibility and control. You can negotiate the terms and interest rates directly with the corporation, tailoring the loan to your needs and financial circumstances.
Watch the video on this topic
Considerations for Risks When Using a Shareholder Loan
While there are benefits, both forms of shareholder loans carry risks.
In the case of a shareholder lending money, there’s a risk of non-repayment by the company, potentially impacting the shareholder’s financial stability.
When a shareholder takes a loan from the company, it’s important to establish clear repayment terms to avoid straining the company’s cash flow. The shareholder should also be on top of repaying the loan within the specified time frame to avoid paying personal income taxes on the loan.
A shareholder loan may not be suitable for everyone. To avoid unintended consequences, consult legal and financial professionals for guidance on a shareholder loan’s appropriate structure, interest rates, repayment terms, and tax implications.
Shareholder loans can be a valuable strategy to integrate into your financial plan. Having a corporation is just step one. Knowing how to use strategies to maximize the use of your corporation is where the magic happens. Book a call today.
