Shareholder Loans: A Complete Guide for Small Business Corporations

When you started your corporation, chances are you dipped into personal savings to get things off the ground. Maybe you covered initial inventory costs, paid for equipment, or funded that first month of rent. Now your business is generating revenue, and you want to pay yourself back—or perhaps your company needs another cash infusion to fuel growth.

This is where shareholder loans come into play. But unlike simply transferring money between personal and business accounts as a sole proprietor might, corporations face strict legal and tax requirements that can trip up even experienced business owners.

Understanding how shareholder loans work—and how to structure them properly—can save you from IRS scrutiny, unexpected tax bills, and the headache of reclassified transactions.

What Is a Shareholder Loan?

A shareholder loan is a formal lending arrangement between a corporation and one of its shareholders. Unlike equity investments (where shareholders receive ownership stakes in exchange for capital), loans create a creditor-debtor relationship with defined repayment terms.

These arrangements flow in two directions:

Loans from shareholders to the corporation: A shareholder provides capital to the business, which the corporation must repay according to agreed terms. This approach benefits businesses that lack established credit histories or want to avoid traditional bank financing.

Loans from the corporation to shareholders: The business lends money to a shareholder, who repays the corporation with interest. Shareholders can access funds without navigating bank loan applications, while the corporation earns interest income.

Both types require careful documentation to maintain their legitimacy in the eyes of the IRS.

Why Proper Documentation Matters

The IRS closely examines transactions between corporations and their shareholders. Without proper documentation, what you consider a loan may be reclassified as:

• Taxable compensation (if the corporation lends to a shareholder-employee)
• Taxable dividends (if treated as a distribution from corporate profits)
• Capital contribution (if a shareholder provides funds without a formal loan structure)

Each of these classifications carries different—and often more costly—tax consequences than a properly structured loan.

The key question the IRS asks: At the time of the transaction, did both parties genuinely intend for the money to be repaid?

To establish this intent, you need documentation that proves the transaction occurred at "arm's length"—meaning the terms reflect what unrelated parties would agree to in a similar situation.

Essential Elements of a Valid Shareholder Loan Agreement

Every shareholder loan should include a written agreement containing:

1. Principal Amount

State the exact loan amount being transferred. This creates a clear record of the original debt.

2. Interest Rate at or Above the AFR

The IRS requires related-party loans to charge interest at or above the Applicable Federal Rate (AFR). As of January 2026, short-term AFR rates are approximately:

• Annual: 3.63%
• Semiannual: 3.60%
• Quarterly: 3.58%

The IRS publishes updated AFR rates monthly. Using a rate below the AFR triggers "imputed interest" rules, where the IRS calculates the interest that should have been charged and taxes both parties accordingly.

Exception: Loans of $10,000 or less are exempt from below-market interest rules, provided the loan is not directly attributable to the purchase or carrying of income-producing assets.

3. Repayment Terms

Specify exactly when and how the loan will be repaid:

• Monthly, quarterly, or annual payment schedule
• Payment amounts (principal plus interest breakdown)
• Loan duration
• Due date for final payment

4. Amortization Schedule

Include a table showing how each payment applies to principal versus interest over the life of the loan. This demonstrates the loan's economic substance.

5. Default Provisions

Outline consequences if payments are missed, including late fees or acceleration of the full balance. Real lenders include these terms; so should you.

6. Collateral (When Appropriate)

While not always required, pledging collateral strengthens the loan's legitimacy, particularly for larger amounts.

Loans from Shareholders: Tax Implications

When you loan money to your corporation, here's what to expect:

For the Corporation

Interest paid on shareholder loans is generally tax-deductible as a business expense, reducing the corporation's taxable income. This can be advantageous compared to equity financing, where dividend payments are not deductible.

For the Shareholder

• Principal repayments are not taxable—you're simply receiving your own money back
• Interest payments are taxable income, reported on your personal return
• The corporation must issue Form 1099-INT if interest payments exceed $600

S Corporation Debt Basis

For S corporation shareholders, loans to the company create "debt basis." This matters because:

1. S corporation losses pass through to shareholders' personal returns
2. You can only deduct losses up to your combined stock and debt basis
3. Debt basis provides additional room to claim losses beyond your stock investment

Important: Only direct loans from you to the corporation create debt basis. Guaranteeing a bank loan does not establish debt basis—even if you're personally liable if the corporation defaults.

If you use debt basis to claim losses, that basis is reduced. Later loan repayments may become partially taxable because they exceed your remaining debt basis.

Form 7203 Requirements

S corporation shareholders must file Form 7203 with their personal tax return to track stock and debt basis when they:

• Claim deductions for pass-through losses
• Receive distributions
• Dispose of stock
• Make or receive loan repayments

This form replaced informal worksheets and gives the IRS visibility into basis calculations.

Loans to Shareholders: Tax Implications

When your corporation loans money to you, the tax dynamics shift:

For the Corporation

Interest received from shareholder loans is taxable income to the corporation. The company must report this revenue even if the shareholder is also the primary owner.

For the Shareholder

• You must report interest paid to the corporation via Form 1099-INT
• Interest expense may be deductible on your personal return, depending on how you used the loan proceeds
• Principal repayments are not taxable events

The One-Year Rule

A critical deadline exists for shareholder loans: the loan must be repaid within one year of the corporation's fiscal year-end. If the balance remains outstanding beyond this period, the IRS may treat the amount as a taxable distribution rather than a loan.

This doesn't mean you can't have multi-year loans—but you need documented payment activity showing genuine debt reduction.

Common Mistakes That Trigger IRS Problems

1. Missing Documentation

The absence of a written loan agreement is the single biggest red flag. Verbal arrangements between related parties rarely survive IRS scrutiny.

2. Charging No Interest or Below-Market Rates

Failing to charge AFR-level interest triggers imputed interest calculations. The IRS will tax both parties as if interest had been charged at the applicable rate.

3. Inconsistent or Missing Payments

The IRS examines whether repayments actually occur as scheduled. In the Gray tax court case, the court noted that "substantial amounts went past due without any collection efforts occurring"—a key factor in ruling against the taxpayer.

Maintain bank records showing payments match your loan agreement.

4. Excessive Loan Amounts

If your corporation continually lends large amounts to shareholders without meaningful repayment, the IRS may argue these are actually distributions or compensation—both potentially more taxable than loan repayments.

5. Open Account Debt Over $25,000

Informal advances that accumulate over time can become problematic. If open account debt exceeds $25,000 at year-end, the IRS may require formal documentation or reclassify the amount.

6. Confusing Loans with Distributions

Taking money from your corporation without clear loan documentation often leads to reclassification as a taxable distribution. This is especially problematic for C corporations, where distributions may be taxed as dividends.

Capital Contributions vs. Shareholder Loans

Before structuring a shareholder loan, consider whether a capital contribution might be more appropriate.

Capital contributions:

• Increase your stock basis
• Don't require repayment
• Create no interest income or expense
• May result in capital gains when you eventually sell shares at a profit

Shareholder loans:

• Create debt basis (for S corporations)
• Require repayment on defined terms
• Generate interest income for the lending party
• Provide flexibility to withdraw funds without distribution tax treatment

The right choice depends on your overall tax situation, cash flow needs, and exit strategy. Many business owners use a combination of both.

Best Practices for Managing Shareholder Loans

Document Everything in Writing

Create a formal promissory note before any funds change hands. Include all required elements: principal, interest rate, repayment schedule, and default terms.

Keep Loan Transactions Separate

Maintain clear bank records showing loan disbursements and repayments. Don't commingle loan transactions with regular business expenses.

Make Payments on Schedule

Actually follow your repayment plan. If circumstances change, formally amend the loan agreement rather than simply skipping payments.

Record Corporate Authorization

Document loan approval in corporate minutes, especially for significant amounts. This reinforces the transaction's arm's-length nature.

Review AFR Rates Before Setting Terms

Check current Applicable Federal Rates at irs.gov before finalizing loan terms. Rates change monthly, and using outdated rates could trigger imputed interest problems.

Track Basis Carefully

For S corporation shareholders, maintain detailed records of stock and debt basis. You'll need this information for Form 7203 and to properly calculate deductible losses.

Consult a Tax Professional

Given the complexity of shareholder loan rules, working with a CPA or tax attorney—especially for larger transactions—can prevent costly mistakes.

When Shareholder Loans Make Sense

Consider shareholder loans when:

• Your corporation needs capital but lacks credit history
• You want to finance the business without diluting equity
• Interest deductions would benefit the corporation's tax position
• You need to access corporate funds without triggering distribution taxation
• S corporation losses exceed your stock basis, and debt basis would allow additional deductions

Keep Your Corporate Finances Organized

Managing shareholder loans requires meticulous record-keeping—from loan agreements and amortization schedules to payment receipts and basis calculations. Beancount.io provides plain-text accounting that gives you complete transparency over these transactions. Track shareholder loans, monitor basis adjustments, and maintain audit-ready records without the complexity of traditional accounting software. Start for free and bring clarity to your corporate finances.