Borrowing From Your Own Business? Here's What the IRS Requires
Many business owners consider taking a loan from their own company instead of a distribution or bonus, and there are legitimate reasons to do this. But the IRS scrutinizes these transactions closely, and getting the details wrong can be costly.
When does an owner loan make sense and for whom?
This depends heavily on your entity type:
C-corp owners: A loan gets you cash now without creating a taxable dividend (taxed to you, no deduction for the company) or a bonus (payroll tax on both sides).
S-corp owners: Same reasoning - plus, if you don't have enough basis, a distribution beyond that basis is taxed as capital gain. A loan avoids that since it's debt, not a distribution.
Partners in a partnership or multi-member LLC: A loan lets you draw cash without reducing your capital account or triggering gain if a distribution would exceed your basis. It also lets one partner access cash without forcing a pro-rata distribution to everyone else.
Sole proprietors and single-member LLCs: This strategy doesn't apply to you. For federal tax purposes, you and your business are the same taxpayer, there's no such thing as a bona fide loan between you and yourself. Moving money is simply a withdrawal, with no independent tax consequence either way. Formal documentation here is a bookkeeping/credit tool, not a tax strategy.
The core tax issue: AFR (Applicable Federal Rate)
Under IRC §7872, any loan between a business and its owner must charge interest at least equal to the IRS's Applicable Federal Rate for the month the loan is made. For August 2026, the annual rates are:
Term | Rate |
Short-term (≤3 years) | 4.10% |
Mid-term (3–9 years) | 4.35% |
Long-term (>9 years) | 4.92% |
If you charge less than the AFR (including 0%), the IRS treats the difference as imputed interest income to the business,even if no interest was actually paid, and may treat the "foregone" interest as an additional dividend or wage payment to you.
Note: a limited $10,000 de minimis exception exists for compensation-related and corporation-shareholder loans, but it does not apply if a principal purpose of the loan is tax avoidance, so it should not be relied on as a planning tool.
Formal requirements for a loan to be respected as a loan
For the IRS (and courts) to treat this as a bona fide loan rather than a disguised distribution or wages, you need:
A written promissory note signed by both parties.
A stated interest rate at or above the AFR.
A fixed maturity date and repayment schedule.
Actual repayments made on schedule (not just on paper).
Proper booking as a loan receivable on the company's books (not equity or an expense).
A reasonable expectation of repayment - the owner's financial ability to repay matters.
Consistent treatment - no pattern of "loans" that are never repaid or repeatedly rolled forward.
What happens if the rules aren't followed
Reclassification as a dividend (C-corps) - taxable to you personally, with no deduction for the business (double taxation).
Reclassification as compensation - triggers payroll tax, withholding, and possibly penalties for underpaid employment tax.
For S-corps could be treated as a distribution in excess of basis, taxed as capital gain.
Imputed interest income to the business, even without cash changing hands - phantom income that still gets taxed.
Increased audit risk, since shareholder loans are a well-known area of IRS scrutiny.
Bottom line: an owner loan can be a smart, tax-efficient tool, but only if it's structured and documented as a real loan from day one, and only if it actually fits your entity type. If you're considering borrowing from your business, let's set up the paperwork correctly before any money moves.
