How to Set Up a Shareholder Loan Account

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The terms of a shareholder loan should be approved by the board of directors.
The terms of a shareholder loan should be approved by the board of directors. (Image: BananaStock/BananaStock/Getty Images)

Shareholders can make loans to or borrow funds from their corporations with approval from a majority of the board of directors. As long as the transaction is recorded in the company's bookkeeping system so year-end reporting to the Internal Revenue Service (IRS) can be done properly, there is no prohibition against it. In fact, many small corporations rely heavily on loans from shareholders to provide cash flow until the corporation earns enough income to support itself. The transaction is recorded on the books in the same way as any loan obligation, such as a bank loan or credit card debt.

Vote to allow shareholder loans to the corporation. Raise the issue at a meeting of the board of directors. Establish repayment terms, including interest rate. If a majority of the board votes to allow the transaction, draft a resolution reflecting the decision. Have the chairman of the board sign the resolution and file it, along with the meeting minutes, with the corporate records.

Draft a written agreement, memorializing the terms of the loan. Use a basic loan promissory note format that details the name of the shareholder making the loan, the date of the transaction, the amount of the loan, the terms of the transaction and a promise by the corporation to repay the money. A sample promissory note can be downloaded from business forms repositories over the Internet or copied from a basic business forms book available in a library or bookstore. The note should be signed by the shareholder and an authorized member of the board as a representative of the corporation.

Set up a liability account for the loan in the corporation's accounting system. Use the general ledger to set up a loan account called "Shareholder Loan -- Name" where the "Name" is the name of the shareholder lending the funds. Post to the account the total amount of the loan, and credit payments of principal whenever they occur.

Set up an interest expense account in the corporation's accounting system. Use the general ledger. Post payments of interest on the loan to this expense account.

Issue an IRS 1099-INT for the interest paid by the corporation to the shareholder at year-end. Any interest paid by the corporation to the shareholder on the loan is income to the shareholder that must be reported to the IRS. This is one of the reasons it is important to separately account for payments of principal and interest on the books.

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