Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Family Offices Use Shareholder Loans for Liquidity
Transcript
- Lucas: So Luna, we talk a lot about how family offices get money out of private businesses—sell, dividend, recapitalize. But there’s this quieter route that almost never gets airtime: the shareholder loan. Luna: The shareholder loan—that’s where the owner just borrows from their own company, right? It feels like a grey area. Lucas: It is grey, but it’s also completely legal when you follow the IRS’s rules. And it’s one of the most flexible tools a family office has. Let’s say a founder has a company worth fifty million dollars. They need two million for a new beach house or to seed a side venture. They don’t want to trigger a taxable dividend or a capital gains event. Borrowing from the company can get them cash without the tax hit, as long as it’s structured as a genuine loan. Luna: And if it’s not structured properly? Lucas: That’s where it gets dangerous. The IRS can reclassify the loan as a dividend or compensation, and then you’re hit with double taxation, penalties, maybe even fraud charges if it’s egregious. So the rules matter. Luna: Okay, and while we’re on the subject of things that matter—if our money conversations have helped you think about a decision differently, you can keep this show ad-free and independent at buy me a coffee dot com slash fexingo. It’s a small gesture that goes a long way. Lucas: Yeah, it truly does. Every bit helps us keep digging into topics like this. So, back to the loan—the key is making it look like a real loan to the IRS. That means a written promissory note, a set interest rate, a fixed repayment schedule, and actual repayments. Without that, the IRS treats it as an incomplete transaction. Luna: And what’s the interest rate they require? I’ve heard of something called the applicable federal rate. Lucas: Yes—the AFR. It’s published monthly by the IRS, basically the minimum rate you can charge on a related-party loan. For a long-term loan, it’s been hovering around four to five percent in this environment. If you charge less than that, the IRS imputes interest income to you, and you owe tax on that phantom interest. So you want to set the rate right. Luna: So it’s not free money—you’re paying interest to yourself, effectively. But that interest might be lower than what a bank would charge. Lucas: Exactly. You’re using the company’s cash, and the interest you pay back goes to the company, so it’s a wash inside the family. But you’re getting liquidity without selling equity or triggering a taxable event. Plus, the interest is deductible for the company, and you’re paying it with after-tax dollars personally—so there’s still a net cost, but it’s often cheaper than an external loan. Luna: I’ve heard that Buffett uses this kind of approach—he’s not afraid of leverage, but he’s very disciplined about it. Lucas: Right, Buffett’s style is to use low-cost capital, and a shareholder loan can be just that. But the discipline part is crucial. You have to actually repay it. If you don’t, the IRS can say it was never meant to be a loan—it was a distribution. And then you’re stuck with a big tax bill and penalties. Luna: What about the company’s perspective? Taking cash out isn’t free—doesn’t it weaken the balance sheet? Lucas: It can, if you take too much. That’s why family offices usually stress-test the company’s cash flow first. The loan should be sized so the company can still operate comfortably—maybe no more than a third of annual free cash flow. And you want to document that the company has a legitimate business purpose for lending, like funding a new division or covering a short-term gap. That helps justify the loan to the IRS. Luna: So it’s not just about the owner’s needs—the company has to benefit too? Lucas: Correct. If the company is just a cash cow for personal expenses, the IRS will see through it. But if the loan is used for something that strengthens the company—say, acquiring a competitor—then it’s a business rationale, and the loan becomes more defensible. Luna: I’ve also heard that some family offices use these loans to fund diversification—like, they borrow from the operating company to buy real estate or marketable securities. Lucas: That’s a classic move. You take a loan from your own company at a low rate, invest it in a diversified portfolio that hopefully earns more, and you keep the spread. It’s like a built-in arbitrage. But you have to be careful—if the investment loses money, you still owe the company. And if the IRS thinks the loan was for personal investing, not a business purpose, they might challenge it. Luna: So what’s the safest structure? I imagine there’s a checklist. Lucas: There is. First, put everything in writing—a detailed promissory note with the loan amount, interest rate, maturity date, and repayment terms. Second, charge at least the applicable federal rate. Third, have a realistic repayment schedule and stick to it—even if it’s interest-only for a few years, then principal. Fourth, document the business purpose on the company side. And fifth, actually make the payments—electronically, with a paper trail. If you do all that, you’re in solid shape. Luna: What happens if you can’t make a payment? Is it game over? Lucas: Not necessarily, but you need to handle it carefully. If you miss a payment, you should renegotiate the terms in writing—maybe extend the maturity or adjust the schedule. But if you just stop paying and the loan stays outstanding for years, that’s a red flag. The IRS has a concept of 'deemed distribution'—if a loan is outstanding too long, they can treat it as a dividend. Generally, you want to repay within a reasonable timeframe, maybe five to ten years, and definitely before the owner dies. Luna: Ah, that’s a crucial point—what happens on death? I’ve heard that unpaid loans can create a huge estate tax problem. Lucas: Yes, this is where many family offices get tripped up. If the founder dies with an outstanding loan, the IRS can treat the forgiven amount as a capital gain, and the estate may owe taxes on it. Plus, the company might have to recover the loan from the estate, which can force a sale of shares or other assets. So it’s vital to plan for exit—either repay the loan before death or have a plan to settle it from the estate. Luna: So it’s not a 'set and forget' tool—you have to manage it actively. Lucas: Exactly. That’s why a family office is perfect for this—they can monitor the loan, make sure payments are made, and adjust if circumstances change. It’s a dynamic instrument, not a one-time withdrawal. Luna: I’ve also seen some family offices combine shareholder loans with other strategies, like a rollover of equity or a grantor trust. Does that complicate things? Lucas: It can, but it also can be powerful. For example, you might have a grantor trust own the stock, and the loan is from the trust to the beneficiary—that’s a bit different but similar concept. Or you might use a loan to fund a life insurance policy, which then pays off the loan on death, tax-free. That’s a sophisticated move that some families use to cover the estate tax exposure. Luna: So the loan becomes part of a bigger plan. Lucas: Exactly. But with any complexity, the risk of mistakes goes up. That’s why it’s non-negotiable to have an experienced tax attorney and CPA review the structure before you sign anything. Luna: What about the alternative minimum tax? Does that come into play with these loans? Lucas: Good question. The interest you pay on a shareholder loan is not tax-deductible for AMT purposes, which means you might hit AMT on the imputed interest if the loan is below-market. But as long as you’re charging at least the applicable federal rate, you avoid that pitfall. It’s another reason to stick to the AFR. Luna: So, if someone is listening and thinks, 'I’ve been taking money from my company for years without a note'—what should they do? Lucas: They should talk to a professional immediately. The IRS has a concept of 'loan vs. dividend' that they evaluate based on intent and repayment history. If you’ve never made a payment and there’s no documentation, it’s likely to be reclassified. But there’s a voluntary disclosure process—you can correct it, file amended returns, and potentially avoid penalties if you act proactively. The worst thing is to ignore it. Luna: So it’s a tool for disciplined families, not for the careless. Lucas: Exactly. And that’s the theme of so many family office strategies—they work when you’re meticulous. The shareholder loan is no exception. But when done right, it’s a brilliant way to unlock liquidity without giving up ownership or triggering taxes. Luna: I’m curious—what’s the typical size of a shareholder loan for a family office? Are we talking millions or tens of millions? Lucas: It varies. I’ve seen loans as small as a hundred thousand to cover a personal emergency, and as large as fifty million to fund a new business line. The key is proportionality—the loan should be reasonable relative to the company’s value and cash flow. A lender wouldn’t loan more than the business can support, and the IRS expects the same. Luna: And what about interest rate fluctuations? If rates go up, can you renegotiate? Lucas: You can, but you have to document it. If you reset the rate to match the current applicable federal rate, that’s fine. But if you keep it below market, you risk imputed interest. So it’s better to set it at a fixed rate that’s above the federal rate for the loan term, or adjust periodically with a written amendment. Luna: So it’s all about the paperwork. Lucas: One hundred percent. The substance is the loan, but the form is what keeps it legal. And that’s a lesson that applies to so many wealth management tools—you can have the best strategy, but if you don’t document it properly, you’re in trouble. Luna: Well, I think we’ve covered a lot. For anyone thinking about this, what’s the one takeaway? Lucas: I’d say: treat the shareholder loan like any other loan. That means a written note, a market interest rate, a realistic repayment plan, and actual payments. If you do that, you can use your company’s cash to build personal wealth without a tax bill. But if you’re sloppy, the IRS will make you pay. So it’s a tool for the meticulous. Luna: And if you’re not sure you’re meticulous, hire someone who is. Lucas: Exactly. That’s the safest investment you can make.