I am starting out a retail business with my life's savings (around 300k). Since this business does not have any property or equipment, I cannot get a business loan (and hence using my savings). I wish to show this initial investment as a LOAN to the business which I will get back over X years with X.X interest. I understand that if I do so then the interest income will be taxable BUT my principal will be returned to me without tax penalty.
1) Is my above understanding correct?
2) Who/What will I need to pull the above off as I start my business (does a CPA help with this ? Business attorney ? Or Do I just have to do something at my end )
If anyone has any experience with this situation, please share your insights.
Contracts on taking this huge step in your life. I am glad you are reaching out now compared to once the transaction has already taken place.
Although there needs to a detailed discussion on what business, who are the partners, and your goals, some general issues need to be addressed.
1) Showing initial investment as a loan to the business does no good. You have to manage a debt relation with your business and it is just a hassle without any benefit. Also, why would you want to get taxed on the interest income?
2) if you just contribute the capital as your contribution/capital to your business, you are not going to taxed on that capital. Looks like your concern is that you are going to be taxed did you dont loan to the business.
3) You can always withdraw your capital from your business without any tax.
I would talk to an attorney if you are doing a partnership to draft a good agreement and with a CPA to get a best out the taxable entities to do your business. Choosing between C-corp, S-corp or LLC might have a huge impact on your taxes.
Let me know if you want to discuss further.
@Ashish Acharya, Thank you very much. My logic for wanting to set it up this way is :
1) I am putting all my life savings into this gig (300k plus CASH savings)
2) The business profits will be taxed, so I will be paying quite a bit of tax and it will be hard for me get my initial investment back quickly.
However, if I loan my $ to the business at a nominal rate , I can get my initial investment back in the first few years - This will reduce business tax as the loan will be an expense/liability for business and the 300K plus principal returned to my savings will not be taxed on my personal business income. The minor interest that I will receive as income will rightfully be taxed as income. However, my initial saving that I have already paid tax on will come back to my account and I will not incur any additional tax.
Can you please review and tell me if my understanding is NOT correct. I am new to business and want to do stuff right so I don't regret it later.
If you are open to this, I will greatly appreciate speaking with you over the phone.
Again, what you are referring to has worse tax implications and complications.
The amount of profit you are going to make will be same with how you treat your initial investment ( capital Vs loan)
Unlike your understanding, Your loan repayments payment by business will not be business expense. You can’t deduct principle payment back, you can only deduct interest expense portion, but you have to pick up interest as income, so there is no benefit.
I think you have wrong understanding of being taxed on the money when you invest it in as capital.
You can always take your capital out without any tax implications.
The only taxable amount will be your yearly net income. When you take out your initial investment, you will not be taxed again.
If this is confusing, feel free to set up a quick call with me. I am more than happy to explain over phone.
@Ashish Acharya, Thank you for clarifying.
When you say one can withdraw capital without tax implications , can this be done only when I sell the business OR can this be done in the first 5 years while the business is operating.
I will give you a call to understand better.
Thank you very much,
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