Family Loan to Your Business: Record It and Put It in Writing

Is money from a relative a loan, a gift or an investment in my business?

Money a relative puts into your business is a loan only if you are legally bound to repay it and both sides intend repayment. A true loan is not income (Publication 334). Money given with no repayment expected is a gift, and money given for an ownership share is an investment. The label sets the books, the interest rules and what happens if the money is never repaid.

A case is not simple when nothing is in writing, the balance has sat for years with no interest or payments, your preparer or bank asks what a large deposit was, the lender is also an owner or lives abroad, or the lender now wants the money back or wants to forgive it.

Gather before deciding: the bank records for each transfer, any note or message about repayment, every repayment since, how the lender is related to you and to the owners, the country where the lender lives, who received the money (the business or you), and the business's tax classification and accounting method (cash or accrual).

What makes a family loan a real loan to the IRS?

The IRS allows an interest deduction on a debt only when you are legally liable for it, you and the lender both intend repayment, and the two of you have a true debtor-creditor relationship (Publication 334). For a bad debt, a debt is genuine when it comes from a valid, enforceable obligation to repay a fixed or determinable sum (Publication 550).

From the lender's side, money lent to a relative with the understanding that it may not be repaid is treated as a gift, not a loan (Topic 453). Neither publication gives a checklist. Helpful records: a signed note with the amount, interest and repayment dates; payments and interest actually made on that schedule; and books that show the same balance year after year. Years of silence, with no payments, no interest and no mention of the debt, point the other way.

What should the written note for a family loan say?

The note should name the parties, the amounts and dates, the interest rate and when payments are due, and carry both signatures.

If the money moved before any paper existed, sign the note now, list the earlier transfers by date and amount, and never backdate it. A term loan's rate is set as of the day the loan was made (26 USC 7872(f)(2)), so how the earlier period is treated, and which month's rate fits a later note, are questions for a preparer before you file.

How do I record a long-term loan from a family member in my business books?

If the money is a loan, record it as a liability, a loan payable named for the relative, not as revenue and not as an owner contribution. Money borrowed through a bona fide loan is not income (Publication 334).

1. When the money arrives, increase the bank account and the loan payable by the same amount. Nothing reaches the profit and loss statement.
2. Each period, record interest expense. If it is not paid, record it as interest payable to the relative, apart from the loan balance, so both tie to the note.
3. Each payment splits into principal and interest. Principal reduces the loan payable; only the interest is an expense. A repayment made before any note exists still reduces the loan payable; what part is interest depends on what you agreed. See recording a business loan.
4. On the balance sheet, show a note that runs more than a year as a long-term liability, with the part due in the next year shown as current.

If the relative lent to you personally and you then put the money into an LLC or corporation, the business's books show either a loan from you or your contribution, not a loan from the relative, unless the business took on the debt itself. See owner contribution or loan to your LLC.

Do I have to charge interest on a family loan, and what is the applicable federal rate?

No federal rule makes a family loan carry interest. A loan with no interest, or too little, can be a below-market loan, and then the lender can be treated as receiving interest at the applicable federal rate (AFR) (Publication 550).

The AFR. The IRS publishes the rates monthly on its applicable federal rates page. Table 1 has a short-term rate (loans up to three years), a mid-term rate (over three, up to nine) and a long-term rate (over nine) (26 USC 1274(d)), each in annual, semiannual, quarterly and monthly columns. For a loan with a due date, the rate for the month the loan is made applies for its term. A demand loan, payable whenever the lender asks, is tested against the short-term rate period by period, and a loan with no due date may count as one, to the extent regulations provide (26 USC 7872(f)).

Below-market. A demand loan is below-market if its rate is under the AFR. A term loan is below-market if the amount lent exceeds the present value of all payments, discounted at the AFR. A note that states a rate at or above the AFR for its term, from the column that matches how interest is paid, is aimed at passing that test.

What the rules reach. Gift loans (where the missing interest is, in effect, a gift to the borrower), corporation-shareholder loans, compensation-related loans and tax avoidance loans. Whether a no-interest loan from a relative to a corporation or partnership falls in one of these is a question of facts. For a below-market gift or demand loan, the lender is treated as giving the borrower the forgone interest and the borrower as paying it back as interest, generally each December 31 (Publication 550). The lender reports that interest, and the gift can bring gift tax rules (Form 709 instructions). For gift tax, a gift loan with a due date counts the gift on the day it is made: the amount lent minus the present value of the payments (26 USC 7872(b)(1), (d)(2)).

Two limits narrow the rules:

• Small loans. The rules do not apply on any day the total loans between the two sides are $10,000 or less; a husband and wife count as one person (26 USC 7872(f)(7)). This covers gift loans between individuals not used directly to buy or carry income-producing assets, and compensation-related or corporation-shareholder loans where avoiding tax is not a principal purpose. A term loan that was over the limit when made can stay under the rules after the balance falls; for a gift loan, that carry-over applies to the gift tax rules (26 USC 7872(f)(10)).
• Gift loans between individuals, up to $100,000. The interest the lender includes and the borrower deducts is capped at the borrower's net investment income for the year, and $1,000 or less counts as zero. The cap does not apply when avoiding tax is one of the main purposes (Publication 550).

Can my business deduct interest paid to a relative, and who reports it?

The business can deduct interest on a family loan when it is legally liable for the debt, both sides intend repayment, the two have a true debtor-creditor relationship, and the loan paid for business expenses; interest on a part-personal loan must be split (Publication 334). The timing rule in the next section also applies. Some taxpayers must limit their business interest deduction (see Form 8990 in that publication, and the small-business test in recording a business loan).

The relative reports the interest as income. Taxable interest includes interest received on loans made to others, and it must be reported even if no Form 1099-INT arrives (Publication 550).

Form 1099-INT. A corporation, partnership or multi-member LLC that pays a relative $2,000 or more of interest in a calendar year in the course of its business may need to file the form. The statute sets that amount for payments after 2025; check the current instructions, because earlier editions print a lower figure (26 USC 6041; instructions). The instructions also exempt interest on an obligation issued by an individual. How the exemption treats a sole proprietor's or single-member LLC's note is not spelled out. If the form is required, get a Form W-9 from the relative first; without a taxpayer ID number, the payer must withhold 24% (instructions). Interest paid to a foreign payee falls outside Form 1099-INT and can carry withholding and other reporting; see money from family abroad.

What happens to interest I owe a relative but have not paid?

A business generally cannot deduct interest owed to a related person who uses the cash method until it pays the interest and the related person includes it in income (Publication 334). This holds even when the business keeps accrual books. Most individuals use the cash method (Topic 453). Relationship is tested at the end of the tax year in which the deduction would otherwise be allowed, so a new owner or a change in how the business is taxed before then can change who is related; the rule keeps applying if the relationship later ends. The wait does not apply to interest the lender must include in income each year even if unpaid, such as forgone interest on a below-market loan (Publication 550).

Aunts, uncles, cousins and in-laws are outside the family list in 26 USC 267, though ownership or trust links can still make a person related.

A relative outside the US. If the lender is not a US person and is related to you as in the table, the deduction generally also waits until you pay, whatever accounting method the lender uses (26 USC 267(a)(3); 26 CFR 1.267(a)-3).

Interest paid by year end can be deducted that year if the other tests are met; interest still owed waits. Interest only added to the loan balance may not count as paid: Publication 550 treats investment interest paid with a new note as unpaid by a cash-method borrower. A preparer can confirm how the related-person rule applies.

How do I forgive a family loan in the company books, and what if it is never repaid?

When a relative forgives a loan, the business removes the loan payable, and the other side of the entry depends on why. Canceled debt is generally taxable, but amounts canceled as gifts, bequests or inheritances are an exception, such as a note forgiven in the lender's will (Topic 431).

• Forgiven as a gift. If the forgiveness is a gift, the loan payable goes down and owner's equity generally goes up, with no income. The exception rests on the lender's real intent to give; a signed release naming the date, principal and interest supports the entry but does not change the facts. When the borrower is a corporation or partnership and the relative is not an owner, who received the gift, and so whether this exception reaches the entity, is a closer question.
• Forgiven interest. Unpaid interest the business has not yet deducted, such as interest still waiting under the related-person rule, is not income when forgiven, to the extent paying it would have been deductible (26 USC 108(e)(2)). The interest payable comes off the books, and the business never deducts it.
• Canceled for another reason. Cancellation can also occur, with no signed release, when the creditor gives up on collecting. Canceled debt is generally ordinary income unless an exception or exclusion applies, such as bankruptcy or insolvency, which is reported on Form 982.
• Just unpaid. A loan that is not being paid has not necessarily been canceled. The liability stays on the books until it is repaid or canceled; when a lender's silence becomes giving up on collecting is a question for a preparer.

The lender's side. Forgiving a debt can be a gift (Form 709 instructions), and the donor, not the business, is generally responsible for any gift tax (IRS gift tax FAQ). If it is not paid when due, the person who receives the gift is personally liable for it up to the gift's value, and the tax is a lien on the gift for 10 years from the date the gifts are made (26 USC 6324(b)). Gifts to one person totaling more than the annual exclusion, $19,000 per recipient, generally require Form 709, due April 15 after the gift year, whether or not any tax is due (Form 709 instructions; Rev. Proc. 2025-32). When the borrower is a corporation or partnership, who counts as the recipient needs a closer look. See gift tax return and annual exclusion.

If the relative is never repaid. The business still owes the money until it is repaid or canceled. The relative's tax treatment is on the relative's return: a genuine loan that becomes totally worthless is generally a nonbusiness bad debt, while money lent with the understanding that it may not be repaid is a gift, with no bad debt deduction (Topic 453).

What if the family member who lent the money is also an owner?

Book a loan from an owner the same way: a loan payable named for the owner if it passes the tests above, and capital if it does not or the owner meant to invest. For a corporation, an advance treated as capital instead of debt can cost the interest deduction; the statute lists factors such as a written promise to pay a fixed sum on a set date at a fixed rate of interest (26 USC 385(b)). An owner who meets the related-person table above has unpaid interest wait for payment. Loans between a corporation and a shareholder are within the below-market rules, with the small-loan exception above (Publication 550).

When a shareholder forgives a corporation's debt as a contribution to capital, the corporation is treated as satisfying the debt with money equal to the shareholder's adjusted basis in it, so it can have canceled-debt income to the extent the debt exceeds that basis (26 USC 108(e)(6)). To categorize an owner's loan and see what it does to basis, read owner contribution or loan to your LLC and shareholder loans to an S corporation.

Example

These examples use US dollars and round, illustrative numbers. The 5% rate stands in for the applicable federal rate in the month the loan is made; look up the real rate each time.

A restaurant LLC and the owner's parents

A restaurant LLC with one owner, taxed as a sole proprietorship and keeping accrual books, receives US$60,000 from the owner's parents on January 2 of Year 1, with nothing in writing. On January 3 they sign a five-year note, dated that day, that lists the transfer and sets 5% interest, at or above the mid-term rate assumed for that month. Assume the business-interest limit does not apply and the parents use the cash method.

• Year 1: the LLC books a loan payable of US$60,000, pays US$3,000 of interest in December and deducts it. The parents report US$3,000.
• Year 2: cash is short and nothing is paid. The books accrue US$3,000 of interest payable, but the parents are the owner's ancestors, so the deduction waits.
• Year 3: the LLC pays US$6,000, the Year 2 and Year 3 interest, deducts US$6,000 and the parents report US$6,000. The US$60,000 principal stays on the books until the note falls due on January 3 of Year 6, and moves to current at the end of Year 5.

An interest-free loan to a daughter's shop

A parent lends US$8,000 to a daughter's sole proprietor shop, for rent and wages, with no interest and no due date (a demand loan). The loan is between individuals, the total is under US$10,000 and the money does not directly buy or carry income-producing assets, so the small-loan exception can apply. The shop still books a loan payable of US$8,000. If the parent lends US$7,000 more, the total passes US$10,000 and the exception stops for those days. The income cap above can limit the interest the parent is treated as receiving; gift tax rules can still reach it.

An uncle forgives a US$25,000 balance

An uncle lent US$25,000 to a nephew's sole proprietor business and forgives the balance, with no interest owed, in a signed release. If he means it as a gift, the business removes the loan payable and increases owner's equity, with no income, because debt canceled as a gift is an exception. That is a US$25,000 gift, above the US$19,000 annual exclusion, so he generally files Form 709 for that year; the return is his, not the business's.

Different for you?

• A relative put in a large sum with nothing in writing, and your preparer or lender asks what the deposit was: whether it is a loan, a gift or capital sets your books and returns. Get bookkeeping help before you file.
• Years of family deposits, payments and interest are unrecorded, or past returns deducted interest you only accrued to a relative: rebuild what was accrued and paid, by year, first; the deduction may belong in the year you paid. See catching up on overdue books and bookkeeping help.
• The relative wants the money back and nothing is in writing: what you owe, and whether any interest counts, depends on what was agreed. Get bookkeeping help to rebuild the balance and the terms to sign.
• The relative lives abroad: see money from family abroad in your business books and gifts and inheritances from abroad.
• The lender is you or a co-owner: see owner contribution or loan to your LLC, or shareholder loans to an S corporation.
• The relative wants to forgive part or all of the loan: the gift tax side is in gift tax return and annual exclusion; get bookkeeping help with the entry and the books and returns that follow.