Borrowing money from your own company is legal if the business is privately held and you treat the transaction like a real loan: a signed promissory note, an interest rate at or above the Applicable Federal Rate, a fixed repayment schedule, and payments you actually make. Skip any of those, and the IRS can recharacterize the whole balance as taxable income to you, with penalties and interest on top. One threshold matter first: if your company is publicly traded, you cannot do this at all. Federal securities law bans issuers from extending, maintaining, or arranging personal loans to their directors and executive officers, and the prohibition reaches subsidiaries too.1Office of the Law Revision Counsel. 15 USC 78m – Periodical and Other Reports Everything below assumes a private C-Corp, S-Corp, or LLC.
What Makes It a Real Loan to the IRS
The IRS decides shareholder-loan cases on the facts, and the question underneath every factor is whether you actually intended to repay the money. Saying so isn’t enough. Examiners look at objective evidence, and their own training materials list the factors they check:2Internal Revenue Service. Valid Shareholder Debt Owed by S Corporation
- A written promissory note signed by both parties.
- A stated interest rate at or above the Applicable Federal Rate.
- A fixed maturity date, not an open-ended arrangement.
- Terms that would be enforceable in court as a real contract.
- A reasonable expectation you can repay given your income.
- Real remedies on default, ideally with security or priority over other creditors.
- Actual repayments hitting the books on schedule.
No single factor decides the case. Failing several at once is where loans collapse. A note that sits on the balance sheet for years without a single payment is the pattern examiners see constantly, and it is the fastest route to recharacterization.
The Interest Rate You Have to Charge
A shareholder loan has to carry interest at or above the Applicable Federal Rate published monthly by the IRS. If it doesn’t, the loan is treated as below-market, and the tax code imputes the missing interest as if it had been paid and then handed back, producing a taxable event.3Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates For a corporation-to-shareholder loan, the IRS treats the shortfall as a constructive distribution from the company to you.
Which rate applies depends on how long the loan runs:4Office of the Law Revision Counsel. 26 USC 1274 – Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property
- Three years or less: the federal short-term rate.
- More than three years, up to nine: the federal mid-term rate.
- More than nine years: the federal long-term rate.
Lock in the rate for the month you execute the loan and write it into the note. Current figures are published on the IRS site.5Internal Revenue Service. Applicable Federal Rates (AFRs) Rulings
The $10,000 Exception
If the total outstanding balance between you and the corporation stays at or below $10,000, the below-market rules don’t apply and you can charge zero interest.3Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates The exception disappears the moment the balance crosses that line, and it doesn’t apply if a principal purpose of the arrangement is avoiding federal tax. For most owners borrowing anything meaningful, this won’t help.
What Happens If the IRS Says It Wasn’t a Loan
If examiners conclude the transaction was never a real debt, they recharacterize the entire principal as taxable income to you. What kind of income depends on your relationship to the company, and both versions are expensive.
Constructive Dividend
For C-Corp shareholders, the usual outcome is a constructive dividend. The whole amount you withdrew becomes taxable at ordinary rates, which reach 37% for 2026 taxable income above $640,600 for single filers.6Internal Revenue Service. Tax Inflation Adjustments for Tax Year 2026 Qualified dividend rates often don’t apply because a constructive dividend was never properly declared. The corporation reports it on Form 1099-DIV, and it loses any deduction it claimed for the “interest” it received, because that interest is now recharacterized too.7Internal Revenue Service. Topic No. 404, Dividends and Other Corporate Distributions
Wages
If you also work for the company, the IRS may instead treat the withdrawal as compensation, which is worse. On top of income tax, the company owes the employer’s 6.2% Social Security tax (on 2026 earnings up to $184,500) and 1.45% Medicare tax, and you owe the matching employee share.8Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates9Social Security Administration. What Is the Current Maximum Amount of Taxable Earnings Combined payroll tax runs 15.3% below the Social Security cap. Because the company never withheld any of this at the time, it also faces penalties for the failure to withhold.
Accuracy-Related Penalty
Either flavor of recharacterization typically triggers an accuracy-related penalty of 20% on the underpaid tax.10Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments Interest compounds daily on the unpaid balance from the original due date. A $100,000 loan that gets recharacterized can easily generate $50,000 or more in combined tax, penalties, and interest by the time the audit closes.
Extra Trap for S-Corp Owners
If your S-Corp loan is recharacterized as a distribution, it reduces your stock basis.11Internal Revenue Service. S Corporation Stock and Debt Basis A distribution within your remaining basis is tax-free, but anything above it hits you as a capital gain. Debt basis doesn’t help; only stock basis counts for this test. If you’ve been running losses through the company for years, your stock basis may already be near zero, meaning the whole recharacterized amount lands as gain. The IRS publishes a dedicated practice unit on this exact question, so it is a topic examiners are trained to work.2Internal Revenue Service. Valid Shareholder Debt Owed by S Corporation
If You Later Forgive the Loan
Deciding years later to cancel the debt rather than repay it produces the same result as recharacterization: a constructive distribution to the shareholder for the full forgiven balance.12Internal Revenue Service. Publication 4681 – Canceled Debts, Foreclosures, Repossessions, and Abandonments C-Corp shareholders get dividend income; S-Corp owners take the basis hit with the same capital-gain risk. Writing the loan off the books doesn’t make the tax problem disappear. It fixes it in place.
Fiduciary and Solvency Limits Before You Borrow
Even a well-papered loan can create trouble if the company can’t afford it. Directors and officers owe a duty to protect the company’s financial health, so a loan to an insider has to leave the business able to pay its creditors and keep operating. Transfers that drain a struggling company can be unwound by creditors or a bankruptcy trustee. The analysis turns on whether the transfer went to an insider (directors, officers, and controlling shareholders all count), whether the company got equivalent value back, and whether the company was insolvent or became insolvent because of the transfer.13United States Department of Justice. Civil Resource Manual 58 – Avoidance Powers Most states apply a version of the Uniform Voidable Transactions Act, and a shareholder loan taken while the company can’t pay its bills is the fact pattern that gets transfers reversed.
S-Corp owners should be especially careful. Treating the corporate account as a personal one gives creditors a straightforward alter-ego argument for piercing the corporate veil and reaching your personal assets. LLC members should check their operating agreement, which usually controls when and how members can withdraw capital; if the agreement is silent, state default rules apply.
How to Paper the Loan Correctly
Getting this right is mostly discipline. The steps aren’t complicated, but skipping any of them hands the IRS exactly what it needs.
Board Authorization
Start with a formal board resolution authorizing the loan. Identify the borrower, the amount, the interest rate, and the repayment schedule. Have every director sign. If your bylaws require shareholder consent for insider transactions, get that in writing too. The point is to show the company’s leadership approved this deal in its official capacity, not that the owner just moved money.
The Promissory Note
Execute a written note that matches the resolution. It should state the principal, the interest rate (at or above the applicable AFR), the payment schedule, the maturity date, late-payment terms, and default remedies. Draft it the way a bank would, because that is the comparison examiners make.2Internal Revenue Service. Valid Shareholder Debt Owed by S Corporation
Transfer and Accounting
Move the funds by wire or check so the paper trail is unambiguous. The company should record a loan receivable on its balance sheet, book each principal and interest payment as it arrives, and report the interest income on its return. Automatic monthly transfers are worth the small effort to set up. Consistent repayment is one of the strongest signs of a real loan, and irregular or missing payments are one of the fastest ways to lose the argument.
Keep It Current
Once the paperwork is signed, don’t ignore it. Make every scheduled payment on time. If circumstances change and the terms need to move, document the change with a new resolution and an amended note. Rolling the balance forward indefinitely, missing payments without penalty, or piling on additional draws all tell the IRS that nobody ever expected this money to come back.