Although it is common practice for corporate officers to take shareholder loans from company coffers, weak or inconsistent recordkeeping can turn this into a serious problem during California payroll tax audits – undocumented loans are often picked up by state tax agencies as unreported “wages.” In order to avoid scrutiny, or a possible tax assessment for failure to report wages, businesses must make sure that their shareholder loans are defensible as bona fide loans, and not advances on payments for services rendered, i.e. wages.

The best ways to minimize risk in this area are:

  1. Make sure that the loan is secured by a promissory note, designating a date for repayment and interest. The terms of the repayment schedule should also be included whenever possible.
  2. If the loan exists at the formation of the Corporation, it should be acknowledged in the Articles of Incorporation.
  3. The loan should be recorded in the corporate minutes with a separate resolution stating that the loan was bona fide.
  4. The loan should be named as such in the general ledger and other company books.
  5. The ledger needs to show repayments on the loan balance.
  6. The corporate income tax returns need to report the loan.

Substantiating shareholder loans through the corporate record will avoid problems in both a tax audit and tax petition.

We regularly represent corporate clients in California payroll tax audits in which shareholder loan payments to corporate officers were assessed as unreported “wages.” If you have questions regarding shareholder loans, or any other corporate tax issues, please contact us.