Financing Conundrum - How To Structure Persona Loans To Be Used For Startup Salaries?

[coffeeguy]

Hi All,

I'm a new member - starting up a coffee brand and distribution company.

We are confused in regards to some financing options, here it is: (i'll just use fictitious numbers and names for ease of examples), owners (persons A and B, only people working for the company) have $60K of initial funding via personal loans from person C. $20K is needed to cover operating loss for the first year, while $40K is needed to pay allowances/salaries for A+B for the first year. $20K is the easy part - C makes a personal loan to the company and gets paid back later down the line without too many difficulties or taxes applied.

But, how to structure the $40K for personal expenses, i.e. salaries/allowances? Because it is from personal sources (person C, and not huge amounts), A+B have the option of treating that as personal gifts, not putting that $40K into the company, living off that $40K and not receiving salaries from the company during 1st year (i.e. money used for living expenses for A+B not income taxed during startup). To pay that $40K back to C, however, we would need to use company income (as soon as company turns enough profit), and that would be income taxed since it would NOT be going to A+B for any actual operating expenses.

Note: A+B have full ownership and management control of the company so can raise/lower salaries as needed, or pay out via dividends.

OPTION 1: The $40K+interest owed to C could be paid back via $40K+interest in higher salaries OR dividends from the company to A+B (for example, 5 years down the line when turning a profit), then A+B could pay C the $40K+interest as a repayment of a personal loan. That $40K+interest on top of normal salaries or in dividends will still be taxed (i.e. no fun!).

OR, OPTION 2: when it comes time to pay back the $40K to C, should A+B take out a loan of $40K+interest from the company, raise their salaries for the next few months/years and have part of the salaries garnished? Still, that 40K will be taxed as A+B need to pay taxes on the total salary amounts (taxes paid on actual salary amounts paid plus amounts garnished).

OR, OPTION 3: since taxes will be paid on the $40K anyway (since used for A+B's personal living expenses), is it just better (less confusing, same end result) for C to INITIALLY loan that $40K to the company and the company just pays it out in salaries (income taxed, obviously) to A+B in the first year? Then the company pays back $40K + interest to person C, for example, 5 years down the line when turning a profit?

I am not familiar enough with tax rates to know how to structure this best, so maybe there are some advantages to income taxing the $40K earlier (option 3) versus later (options 1 or 2). Anything we should consider re: the differences between taxing dividends and taxing income?

Any suggestions on what is the best way to structure this?

Thanks for any help you can provide!

-Warren

[SeattleCPA]

Pretty detailed scenario, so I may have missed something.... but in general you don't want to put money into an entity only to take it out again as salary for the owner. The roundtrip ticket price on that set of transactions is often the 15.3% payroll tax...

[torka]

Sounds to me like you should consult with a tax professional who's familiar with your situation. Relying on free forum advice for complicated scenarios with significant tax implications is probably not the best course of action.

I'm sure Steve's advice is right on the money, given the limited information we've been given about the circumstances. But IMO it would be well worth a "real" consultation with with a qualified pro who can review your situation in more detail.

My

--Torka

[SeattleCPA]

Originally Posted by torka

Sounds to me like you should consult with a tax professional who's familiar with your situation....

Yeah, I agree with Torka here. You can buy an hour of sometimes time for, say, $200. That'll seem cheap if it saves you from making a $5,000 mistake... which is easy to do when you're talking about taxes.

Good luck

[coffeeguy]

Thanks folks. I'll surely consult with a tax professional to make sure I'm taking the right course of action. The last thing I want to do is get myself into trouble with the boys over at IRS.

SeattleCPA - thanks for your response. I see how I don't want to put money into a company just to pay it back out through salaries, but when it comes time to pay back those personal loans, I will need to use income generated by the company. The question is then: how to get it out of the company? If it needs to go back to an owner to pay back the personal loan, then it will need to go from the company to the owner via salary or dividends, or via one of the other methods I mentioned in my original post.

Anyway, it seems that we have ourselves in an uncomfortable positions. I'll consult with a tax professional for further information.

[SeattleCPA]

Originally Posted by coffeeguy

...The question is then: how to get it out of the company? If it needs to go back to an owner to pay back the personal loan, then it will need to go from the company to the owner via salary or dividends, or via one of the other methods I mentioned in my original post.

You would often want to treat the loan repayment as just that... a loan repayment.

E.g., when you pay back a real bank loan in a business, you don't call it dividends or wages or whatever... it's a loan repayment. In bookkeeping terms, you credit cash and debit the loan liability account. Repayment then doesn't effect the profit or loss statement... only the balance sheet.