Can I pay myself interest on capital I've loaned my business?

[razor2020]

Over the years I have invested a large sum of money (~150k) in my LLC to build the business and my partner was unable (or unwilling) to put in any money. I have repaid most of the money back to myself over several years from the company but I feel I should have been paid interest on this since my partner put in nothing. Some of this was on credit cards and loans in the beginning that cost me a lot of interest expense from my own pocket to repay. I didn't realize I would be putting that much in when it started so we didn't go into it with an agreement on paying interest beforehand. In hindsight, I should have gotten a promissory note on it with interest. My partner would be okay with it if it's legal from an IRS standpoint.

Any ideas on whether this is the correct thing to do in this situation?

Thanks for any help!
Robert

[IADS]

As far as I know a business that is incorporated, or formed as a LLC is considered a separate entity from yourself. That being said, it becomes a contract issue between you and the business, even if it was a verbal contract. Did you agree ahead of time to charge interest? Did your partner know the amounts that you were loaning the business? What did your partner agree on before the money was loaned? What is your percentage of membership in the LLC? If over 50% you can out vote lesser members, and basically make decisions on your own with notification to other members.

Note: I am not a lawyer. I have worked as a paralegal for five years in California. I am no longer a paralegal. A large part of my job was helping clients form corporations and LLC's. Laws differ from state to state.

[razor2020]

Thank you for the reply IADS. There was no agreement beforehand as the cash injection was just made by me as needed over time and just kept adding up. Sometimes I held my paychecks and he still got his but he was going through a nasty divorce and personal bankruptcy (from trading stock options) so his involvement in the business side of things was minimal. We are 50/50 or I would have removed him long ago for his lack of participation and our attorney in the beginning did not have us do a partnership agreement to start the company with (ugh!) so all we have is the most basic LLC to go by. That's pretty dumb considering gross sales of about $15 million over the years. If I could start over there would be lots of things done differently! He would be okay with my getting some interest as he knows he hasn't done his share as long as it's legal tax / corporate wise.

[IADS]

You are an individual loaning money to a separate business. They were loans, not contributions to the LLC. Pay your taxes on any interest that you take back and there should be no problems. Try to keep good records, or gather and make copies of any receipts, and record that you can dealing with any monies loaned to the company. If your partner agrees make a payback contract/promissory note and back date it. Turn it all over to your tax people and let them worry about it. I'm sure with a $15 million dollar business you're not doing your own taxes.

[Business Attorney]

My partner would be okay with it if it's legal from an IRS standpoint.

This is the key. This really amounts to just another way to split the pie. Stating the amount as interest is probably the better way to go, but in any case partners in a partnership are free to allocate income and expenses between themselves in an manner they agree, as long as the allocations have "substantial economic effect." Assuming the LLC is treated as a partnership for Federal tax purposes, you could always give a preferred allocation to yourself for putting up the capital. If the LLC is taxed as a S corp, the "one class of stock requirement" prevents such special allocations, but payment of interest on loans from shareholders (but not on equity capital) would be the way to go.

The bottom line is that the IRS doesn't care how you divide the profits of the business between yourselves as long as you are doing the allocation for the right reasons and not trying to game the system.