Are loans due to or due from shareholders a bona fide debt obligation, a form of equity capital, or a hybrid of the two? This distinction is relevant when valuing a business – particularly in a shareholder dispute or in a divorce case. I customarily devote a good portion of class time discussing this issue in my class at Fordham Law School. This distinction may cause a material difference in the ultimate valuation of a closely-held business or even the income attributed to its owner. Often, experts turn to the Internal Revenue Service for objective guidance on this issue. What Would The IRS Say? Owners occasionally borrow funds from their businesses, say, to pay a child’s college costs or provide a down payment on a vacation home. These loans to shareholders appear on a company’s balance sheet as a receivable. For loans of more than $10,000, the IRS requires taxpayers to treat the transaction as a bona fide debt. Then the company must charge the shareholder an “adequate” rate of interest. Each month the IRS publishes its applicable federal rates (AFRs), which vary depending on the term of the loan. If the company doesn’t charge interest or follow a complicated set of below-market interest rules to impute interest on the loan, the IRS may claim the shareholder received a taxable dividend or compensation payment rather than a loan. The company may deduct the latter, but it will also be subject to payroll taxes. However, both dividends and additional compensation […]
Yearly Archives: 2020
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Classifying Shareholder “Loans” In Business Valuation
Posted in Business Valuation, on Jan 2020, By: Mark S. Gottlieb