Yes, you can borrow money from your own company if it is privately held, but the IRS treats every dollar that moves from the business to an owner with suspicion. To keep the transfer from being reclassified as taxable income, borrowing money from your own company has to look and behave like a real loan: a written note, an interest rate at least equal to the IRS’s published minimum, formal approval, and actual repayments on a set schedule. Get any of that wrong and the “loan” becomes a distribution, with back taxes, interest, and penalties that can reach 75% of the underpayment.
Whether Your Company Can Lend to You at All
If your company is publicly traded, stop here. Section 13(k) of the Securities Exchange Act, added by Sarbanes-Oxley in 2002, makes it unlawful for any issuer to extend, maintain, or arrange a personal loan to any of its directors or executive officers, including through a subsidiary.1Office of the Law Revision Counsel. 15 USC 78m – Periodical and Other Reports Narrow exceptions exist for home improvement loans, consumer credit, and broker-dealer margin lending, but only when those products are offered to the public on the same terms. Loans that were on the books before July 30, 2002 are grandfathered as long as they haven’t been materially modified. Violations carry civil and criminal penalties.
Everything below applies to private corporations and LLCs, where these loans are legal but heavily regulated by tax law.
What Makes It a Real Loan in the IRS’s Eyes
The IRS uses a multi-factor test to decide whether a transfer from your company was genuinely a loan or a disguised payout. No single factor decides the question, but failing several is a fast track to reclassification. Auditors look at whether there is a written agreement, a stated interest rate, a fixed maturity date, an enforceable right to collect under state law, a reasonable expectation of repayment, security or creditor priority in the event of default, and whether actual repayments were made on schedule.2Internal Revenue Service. Valid Shareholder Debt Owed by S Corporation
Most shareholder loans collapse on the “reasonable expectation of repayment” factor. If you owe the company $200,000 on a $60,000 salary with no other assets, no examiner will believe anyone expected you to pay it back. History hurts too. Prior “loans” that were rolled over or quietly forgotten show a pattern, and the pattern is what the IRS argues from.
The Minimum Interest Rate You Have to Charge
You cannot lend at zero interest between a company and its owner without tax consequences. Under IRC Section 7872, below-market loans between a company and its shareholders trigger imputed interest: the IRS treats the lender as having earned interest income even though no cash changed hands.3Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates The forgone interest is treated as passing from the lender to the borrower and then back again as an interest payment, creating phantom income for the company.
The floor is the Applicable Federal Rate (AFR), which the IRS publishes monthly under IRC Section 1274(d) in three tiers based on loan duration:4Office of the Law Revision Counsel. 26 USC 1274 – Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property
- Short-term, three years or less: 3.59% annually as of March 2026
- Mid-term, over three but not over nine years: 3.93% annually as of March 2026
- Long-term, over nine years: 4.72% annually as of March 2026
The rate that matters is the one in effect when a term loan is made, or the rate during the period being measured for a demand loan with no fixed maturity.3Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates Updated rates appear in the monthly revenue rulings.5Internal Revenue Service. Revenue Ruling 2026-6 Check the current rate before finalizing the note; even a fraction below the AFR creates phantom income.
The $10,000 Exception
Section 7872 does not apply on any day when the total outstanding balance between the borrower and lender stays at or below $10,000.3Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates A small, short-term advance can technically carry zero interest. Two catches. The exception vanishes if one of the principal purposes of the interest arrangement is avoiding federal tax. And the $10,000 ceiling is the aggregate of all loans between you and the company, not each loan on its own. Owe $8,000 already and take a $5,000 advance, and the entire balance is subject to the AFR rules.
The Paperwork That Protects You
A signed promissory note is the foundation of any defensible loan. It should name the company as lender and you as borrower using full legal names, state the principal amount, set an interest rate at or above the applicable AFR, and fix a maturity date. Specify whether payments are monthly, quarterly, or a single balloon at maturity. A note that says “repay when convenient” or leaves the maturity open looks like an indefinite transfer of wealth, not a debt.
Then follow the schedule. The IRS weighs whether repayments were actually made or the parties complied with the terms as one of its bona fide factors, and a beautifully drafted note that nobody follows is barely better than no note.2Internal Revenue Service. Valid Shareholder Debt Owed by S Corporation
Before any money moves, the company’s decision-makers have to formally approve the loan. For a corporation, the board of directors votes on a resolution authorizing the amount, rate, repayment schedule, and borrower. For an LLC, follow whatever the operating agreement requires. The resolution goes into the corporate minutes as a permanent record. That approval does two things beyond good governance: it shows the transaction was handled at arm’s length, and it demonstrates that the decision-makers considered the impact on company liquidity before releasing funds.
Transfer the money by wire or company check. Cash leaves no trail and looks suspicious under audit. Keep the note, the resolution, and the bank records together in the corporate file.
What Reclassification Actually Costs
If the IRS decides the “loan” was never a real debt, it reclassifies the transfer as a taxable distribution. For a C corporation, the payment typically becomes a constructive dividend, taxable to you at dividend rates without giving the company any deduction. The business gave away money it can’t write off, and you owe tax on receiving it. For an S corporation, the reclassified amount reduces your stock basis and becomes taxable once it exceeds that basis.6Internal Revenue Service. S Corporation Stock and Debt Basis
The tax is only the start. Accuracy-related penalties add 20% of the underpayment when the IRS finds negligence or a substantial understatement.7Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments In civil fraud cases, the penalty jumps to 75% of the fraud-attributable portion of the underpayment.8Office of the Law Revision Counsel. 26 USC 6663 – Imposition of Fraud Penalty Both stack on top of interest that compounds from the original due date. Take $100,000 in 2022, get audited in 2026, and you’re looking at the original tax plus four years of compounding interest plus a 20% or 75% penalty on top of that.
If the Loan Gets Forgiven Later
Forgiving the balance instead of collecting it is not a gift in the eyes of the IRS. When a corporation cancels a shareholder’s debt, the forgiven amount is treated as a constructive distribution to the shareholder. For a C corporation shareholder, that generally means a taxable dividend to the extent the company has earnings and profits. The general canceled-debt rule also applies: forgiven debt is ordinary income, reported on your Form 1040, and you may receive a Form 1099-C.9Internal Revenue Service. Publication 4681 – Canceled Debts, Foreclosures, Repossessions, and Abandonments If you’re thinking of forgiving a shareholder loan as a creative form of compensation, the IRS sees through it and the tax bill arrives either way.
S-Corp Owners: The Basis Trap
S-corporation shareholders face a specific wrinkle. Your ability to deduct S-corp losses on your personal return is limited to your combined stock basis and debt basis, and debt basis only counts for loans you personally made to the corporation, not loans the corporation made to you.6Internal Revenue Service. S Corporation Stock and Debt Basis Borrowing from your S-corp does not increase your basis in any way.
On the distribution side, non-dividend distributions are tax-free only up to your stock basis, and debt basis doesn’t count in that calculation.6Internal Revenue Service. S Corporation Stock and Debt Basis If prior distributions have already reduced your stock basis to zero, any amount the IRS moves from “loan” to “distribution” becomes taxable gain. The basis math can turn a reclassification into a much bigger tax bill than you expected.
What You Spend the Money On Affects the Interest Deduction
Federal tax law doesn’t restrict what you do with borrowed money, but it cares about the use when deciding whether the interest you pay is deductible. Use the proceeds in a trade or business and the interest flows to Schedule E. Put the money into investments and the interest goes on Form 4952 as investment interest expense, subject to limits. Spend it on personal items like a vacation or a car and the interest is generally not deductible at all.10Internal Revenue Service. Instructions for Schedule K-1 (Form 1120-S) (2025)
Same loan, same rate, very different after-tax cost depending on the purchase. Keep records showing where the proceeds went. If the IRS accepts the loan as legitimate, the next question is whether you allocated the interest deduction correctly.
Careless Loans Can Pierce the Corporate Veil
The tax consequences aren’t the only risk. When a controlling shareholder pulls assets out through loans that never get repaid, courts may treat the company as an alter ego rather than a separate legal entity. If a creditor later sues and the company can’t pay, that creditor can ask a court to hold you personally responsible for company debts.
Courts generally look for domination of the company by the shareholder plus some harm to third parties. Large undocumented loans without board approval and without repayment tick both boxes: the company looks like a personal account, and creditors who can’t collect are the ones hurt. The protection is the same as the tax protection. Treat the loan as a real transaction between separate parties, document it, and pay it back on the schedule you signed.