June Shaw agreed to advance up to $1 Million to her family’s company, SRG, pursuant to an unsecured revolving line of credit note. June Shaw advanced $808,475 to SRG pursuant to the Note. SRG began facing financial difficulties but June kept making advances under the Note. In 2009, her brother Kenneth Shaw, president of SRG, advised June that the company could not repay her. June listed the amount as a bad debt on her tax return. The IRS denied the deduction and was upheld by the Tax Court.
On appeal, the Ninth Circuit upheld the Tax Court’s ruling. It held that the advance was not a bona fide debt that arose from a debtor-creditor arrangement. “Notably her behavior was not consistent with that of a traditional lender; she continued to advance money to SRG despite its unstable finances and the company’s failure to repay any interest or principal.”
If you are intending to treat advances to your closely held company as loans, it is important that you act like a “real” creditor and document and treat the advance as a loan. A real creditor would require a note to document the loan, would stay aware of the company’s finances and ability to repay the debt, would require regular payments and depending on the amount loaned, would require collateral security. If you fail to follow the formalities of a “real” lender-borrower relationship, you may find that your advance is not afforded the same tax treatment as a bona fide loan.
If you have any questions about family loans to family or other closely-held businesses or any other aspect of family businesses, please contact:
firstname.lastname@example.org or 312-368-0100.