Loans

What are loans from your corporation doing in this list? Loans aren't compensation, are they?

Loans from a business to an owner can get reclassified as compensation (or, worse yet, as dividends) by the IRS. (If the loan is from your partnership, then it could be recharacterized as a taxable distribution, rather than a non-taxable loan.) Not only will you pay tax on the full amount of the "loan" proceeds, the corporation will be denied the corresponding deduction.

The temptation for a small business owner to use his company as a bank is a mighty one, and one to be mightily resisted. The owner of a closely held corporation is able to borrow from the company on favorable terms and repay when convenient: these two considerations are usually absent with outside lenders. Going the other way, an owner can also make loans to the company and earn a self-determined rate of interest. And the potential for the abuse of these powers inspires the IRS to heightened vigilance in this area.

And don't even consider living off periodic disbursements from your business which you "think of" as loans. You'll get taxed on them, perhaps even with payroll tax penalties, and your company won't get a corresponding deduction. Many owners, in tough years, try forego taking a salary and just "borrow" enough from the business to live on. The audit risks and increased tax liabilities are significant and not worth it.

In order to avoid reclassification, loans must:

• must be documented in writing;
• have a set repayment schedule—one that is adhered to, not just a pretty chart to hang on your wall; and
• an interest rate that can be considered consistent with the going market rates charged by third parties.

Below-market or no-interest, "on demand" loans just won't hack it. The IRS will "impute" interest at the market rate if you fail to do so. This means the corporation will pay tax on an amount of interest it never even received, but you will not be able to claim a deduction!