Tax Implications of Guaranteeing a Loan to Your Business

1. If a guarantor is required to pay principal or interest on a loan guaranteed by their corporation, it may result in a bad debt deduction.

2. The bad debt may be classified as either a business or nonbusiness bad debt, with different tax implications for each type.

3. For the guarantee to be treated as a business bad debt, it must be closely related to the guarantor’s trade or business, with employment as the dominant motive in the case of job guarantees. – Guaranteeing a corporation’s loan that is not closely related to the trade or business can result in a nonbusiness bad debt deduction if it can be shown that the reason for the guarantee was to protect an investment or entered into the transaction with a profit motive.
– To qualify for a deduction, the person guaranteeing the loan must have a legal duty to make the payment, the guaranty agreement must have been entered into before the debt became worthless, and reasonable consideration must have been received for entering into the agreement.
– Any payment made on a guaranteed loan is deductible as a bad debt in the year it is made, unless there is a right to demand payment from the corporation. In such cases, the bad debt deduction can only be taken when the rights become partly or totally worthless.
– It is important to consult with a tax professional to understand all the tax implications of guaranteeing a loan to a closely held corporation.

Guaranteeing a Loan to Your Corporation? There May Be Tax Implications