Should you or should you not loan money to employees? It depends on the situation of course, and it is never one-size-fits-all. However, a good solution is to offer your employees the chance to open an account in your company-sponsored 401(k) plan. It is possible for him or her to take money out of the account if the plan allows loans, and it won’t be considered a business transaction. This way, you won’t be a lender, but you can still help out your employee. The employee is allowed to borrow half of his or her account balance, at a maximum of $50,000, which must be paid back within five years. If you and your employee decide to move forward, keep in mind that the plan must charge a reasonable interest rate. Also, repayment must be made in consistent payments over the course of five years–unless the loan is going towards the purchase of a home.
The Fine Print
- Before going ahead with the loan, the employer should always sign a promissory note stating the terms of repayment, decided upon by both parties. These terms should include the frequency of the repayment, what to do in the case of a default, and the interest rate.
- If the loan is not personal, remember to record it in your books so that it won’t be treated as income.
- For tax purposes, reference the below-market loan rules.
- If the loan is over $10,000, your business must charge interest at the applicable federal rate (AFR). If this does not happen, your business could end up with phantom income
Thinking of entering into a loan? It is a good idea to read up on the current AFRs issued monthly by the IRS.