As new businesses are starting out, it can be difficult to establish a steady cash flow to cover expenses. Business owners often want to “lend” their business money here and there to make sure the company stays operational. In many cases, where the business only has one member or owner, these loans go undocumented and no interest is paid when the principal is paid back.
Once you decide to use your personal funds to invest in your business, you’ll need to work with your accountant to determine if the money should be treated as equity or as a loan to the business. Either way, the transfer of funds between owner and business should be well documented in the company’s accounting records.
An equity investment, commonly referred to as a capital contribution, is when the owner transfers money into the business only for an increase in the owner’s equity. This is not a taxable event and the money is not expected to be repaid. However, the contribution date and amount still needs to be documented in writing to adjust the owner’s equity in the company.
On the other hand, a loan is a transfer of money to the company that is expected to be repaid with interest over a period of time. The loan should be documented with a written promissory note identifying the amount of principal, interest rate, and time period. Interest paid by the business will be documented as a deductible business expense on the business tax return. Similarly, the owner will document the interest income on his or her tax return.
It is important to remember that transferring other personal assets to the business besides cash should also be documented in the same way. You need to decide whether property and assets used in the business are contributions or leases to the business and record the transaction accordingly.
Before simply transferring a few thousand dollars (or more!) over to your business checking account, work with your accountant and attorney to decide on the best structure for the transfer and the appropriate paperwork needed. Taking this simple step can save time and money later when these transactions may be called into question.