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Be Careful When Making Loans to a Related Party


Tuesday, August 1, 2006
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If you lend money to your closely held corporation or to a member of your family, be sure to handle the transaction with all of the formalities of an "arm’s-length" loan to a stranger. The IRS carefully scrutinizes loans where the lender and the borrower are "related."

 

In the case of a "loan" to a family member, the IRS often claims that the purported loan was actually a gift and there was never any intention that it would be repaid. It will therefore generally challenge a claimed bad-debt deduction when such a "loan" goes bad.

 

In the case of a "loan" by a shareholder to his or her corporation, the IRS frequently takes the position that the money advanced was actually an additional capital investment—stock rather than true debt. If the IRS does accept the loan as valid, it may tax the shareholder on the difference between current arms-length interest rates and any lesser interest actually charged.

 

That’s why the formalities are so important in making a loan to a related party. 

Here are some of the things you might do to try to insulate a related-party loan against IRS attack:
•  Evidence the loan with a note (avoid open account or handshake deals).
•  Provide for a fair rate of interest and have it paid regularly. 
•  Provide for security (if possible).
•  Set a maturity date.
•  Spell out when repayments are to be made and have them made in accordance with these terms.

 

In the case of a loan to a closely held corporation, there are certain other tax factors that should be considered, for example, whether the ratio of loans to stock is "excessive." Where the ratio is excessive, the corporation may be denied a deduction for interest paid on the loan (in addition to the risk that the loan will be treated as an additional capital investment).

 

Tax Due Dates for August 2006

 

August 10th : Employers Social Security, Medicare, and withheld income tax. File form 941 for the second quarter of 2006. This due date applies only if you deposited the tax for the quarter in full and on time.

 

Employees who work for tips. If you received $20 or more in tips during July, report them to your employer. You can use Form 4070.

 

Employers – Nonpayroll withholding. If the monthly deposit rule applies, deposit the tax for payments in July.

 

Employers – Social security, Medicare, and withheld income tax. If the monthly deposit rule applies, deposit the tax for payments in July.

 

Chuck Chuckuemeka is managing partner of Chuckuemeka & Associates, a nationally focused CPA firm specializing in Accounting, Auditing, Consulting and Tax Advising. Visit them at www.chuckcpa.com

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About Chuck Chuckuemeka

Chuck is managing partner of Chuckuemeka & Associates, a nationally focused CPA firm specializing in Accounting, Auditing, Consulting and Tax Advising.

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