What Is a Director’s Loan and How Does It Work?

A director’s loan is any transfer of money between a company and one of its directors, officers, or shareholders that isn’t salary, a bonus, or a dividend. It creates a debtor-creditor relationship the IRS watches closely, and getting the paperwork or the interest rate wrong can turn the whole balance into taxable income. Public companies registered with the SEC generally can’t make personal loans to directors and executive officers at all. Private companies can, but only if the loan looks like a real loan on paper and in practice.

How the Loan Account Tracks the Money

A director’s loan account is a running ledger of every financial exchange between a director (or officer or shareholder) and the company that falls outside normal compensation channels. When the director takes money out, the balance rises and shows the director owes the company. When the director puts personal funds in, the balance falls or flips, showing the company owes the director. One account, two directions.

Under U.S. accounting rules, these balances can’t be folded into general receivables or payables. Amounts owed by officers, employees, or affiliated parties have to appear separately on the balance sheet rather than sitting under a generic line like “notes receivable.”¹ That separation is what lets creditors, investors, and tax authorities see related-party dealings for what they are.

When a Director’s Loan Isn’t Allowed at All

If the company is publicly traded, stop here. Federal securities law makes it unlawful for any SEC-registered issuer to extend, maintain, or arrange credit in the form of a personal loan to any director or executive officer.² That prohibition came in with the Sarbanes-Oxley Act in 2002. Narrow carve-outs exist for banks and other consumer-credit businesses lending on the same terms they offer the public, and for loans that were already in place before July 30, 2002 and haven’t been materially modified since. Everything below applies to private companies, where director’s loans are legal but heavily regulated.

Documenting the Loan So It Looks Like a Loan

The single most important step is building a paper trail that proves the transaction is genuine debt rather than disguised compensation or a dividend. The IRS expects an arm’s-length transaction: a written contract with a stated interest rate, a specified repayment timeline, and consequences for failure to repay.³ Collateral helps too.

At a minimum, a properly documented director’s loan includes:

A written promissory note stating the principal, interest rate, maturity date, and repayment schedule.
A board resolution formally authorizing the loan in recorded minutes (or shareholder approval if the bylaws require it).
An interest rate at or above the applicable federal rate (AFR) for the relevant month.
Actual repayment activity. Regular on-schedule payments are what turn a well-drafted note into a defensible loan.

Skip any of these and the IRS has room to argue the amount was never really a loan. When that happens, the money gets reclassified, usually as a constructive dividend or additional compensation, and the tax bill lands immediately.

Interest Rates and the Imputed Interest Problem

Charging a director-shareholder a below-market interest rate, or no interest at all, doesn’t just save the borrower money. It pulls the loan into Section 7872 of the Internal Revenue Code, which applies to any below-market loan directly or indirectly between a corporation and any shareholder of that corporation.⁴

How the Imputed Interest Calculation Works

For a demand loan (no fixed maturity, or payable whenever the lender asks), the IRS measures the gap between what the borrower would have paid at the AFR and what was actually charged. That gap, called forgone interest, is treated as two separate transfers: the corporation is deemed to have paid the shareholder an amount equal to the forgone interest (typically a dividend), and the shareholder is deemed to have paid that same amount back to the corporation as interest.⁴ No cash moves, but both sides owe tax as if it had. The corporation reports the imputed interest as income; the shareholder reports the deemed dividend.

The AFR resets each month. For January 2026, the short-term AFR used for demand loans was 3.63% compounded annually.⁵ The rate in effect for each period of the loan controls that period’s calculation. On the personal return, the imputed interest is reported as taxable interest income on Form 1040.⁶

The $10,000 De Minimis Exception

Section 7872 doesn’t apply on any day when the total outstanding balance between the borrower and lender is $10,000 or less.⁴ Small short-term advances that stay under the line escape the imputed interest rules. The exception vanishes, though, if one of the principal purposes of the interest arrangement is federal tax avoidance. Splitting one large loan into several small ones to duck the threshold won’t hold up.

The Constructive Dividend Risk

The worst outcome isn’t imputed interest. It’s the IRS deciding the loan was never a loan at all. When a corporation transfers money to a controlling shareholder with no realistic expectation of repayment, the whole amount can be reclassified as a constructive dividend. The shareholder owes income tax on the full sum, and the corporation gets no deduction. Both sides pay, and neither has the flexibility that a properly declared dividend or salary would have offered.

Factors that support loan treatment:

A signed promissory note with a fixed maturity date
A stated interest rate at or above the AFR
Security or collateral behind the loan
An actual repayment history with regular on-schedule payments
A ceiling on how much the corporation can advance
The borrower’s demonstrable ability to repay from salary, other income, or net worth

Red flags pointing the other way: a controlling shareholder who sets the terms alone, a company with accumulated earnings that never pays dividends, repeated “loans” that never get paid back, and a borrower whose ability to repay depends entirely on uncertain future events.⁷ A pattern of shareholder withdrawals booked as loans, in a company with the capacity to pay dividends but no history of doing so, reads to the IRS as earnings being quietly diverted.

When the Director Lends Money to the Company

The loan can move the other way too. Directors regularly put personal funds into the business to cover operating costs, bridge a cash-flow gap, or reimburse themselves for supplies bought on a personal card. That creates a credit balance in the loan account: the company now owes the director.

Getting the money back is usually straightforward. Because the director is recovering funds already earned and taxed, the return of principal doesn’t create new taxable income.⁸ If the company pays interest on the advance, that interest is taxable to the director and typically deductible by the corporation as a business expense.

Debt Versus Equity

The risk on this side is that the IRS treats the advance as a capital contribution instead of a loan. If it does, the director can’t withdraw the money tax-free later. Any return of the funds may be treated as a dividend distribution.

The IRS weighs several factors:⁹

Whether there’s an unconditional obligation to repay a fixed sum by a reasonably close maturity date, regardless of company incomeli>
Whether the lender can actually enforce payment of principal and interest
Whether the director’s claim ranks below general creditors (subordination pushes toward equity)
Whether the company is thinly capitalized, with little equity relative to shareholder debt
Whether both sides consistently treat the instrument as debt on the books, in financial statements, and in dealings with outside lenders

A formal promissory note, a market-rate interest rate, a realistic schedule, and payments that actually happen do most of the work in avoiding reclassification.

What Forgiveness Does

If the corporation forgives a loan it made to a shareholder-director, the forgiven amount is generally treated as a distribution, usually a constructive dividend to the extent of the corporation’s earnings and profits. The shareholder owes income tax; the corporation gets no offsetting deduction. If the loan was originally tied to compensation, the forgiven balance may instead be treated as wages subject to payroll taxes.

The reverse is treated differently. When a shareholder gratuitously forgives a debt the corporation owes, the transaction is treated as a contribution to the capital of the corporation to the extent of the principal.¹⁰ The corporation recognizes no income from the forgiven debt, and the director loses the ability to pull those funds back out tax-free.

Where It Shows Up on Tax Filings

Corporations filing Form 1120 report outstanding loans to shareholders on Schedule L (Balance Sheets per Books), which tracks the beginning and ending balances.¹¹ Some small corporations are exempt from Schedule L, but any company carrying a material shareholder loan balance is better off completing it for the audit trail.

On the personal side, any imputed interest from a below-market loan has to appear on the shareholder’s return. The corporation reports the imputed interest as income, and the director reports it based on how the deemed transfer is characterized, often as a dividend.⁶ Reconciling the loan account against bank statements throughout the year, instead of at tax time, is what keeps the numbers clean and the filings defensible.

1
eCFR. 17 CFR 210.9-03 – Balance Sheets
2
Office of the Law Revision Counsel. 15 USC 78m – Periodical and Other Reports
3
Internal Revenue Service. Paying Yourself
4
Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
5
Internal Revenue Service. Section 1274 – Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property (Rev. Rul. 2026-2)
6
Internal Revenue Service. Publication 550 – Investment Income and Expenses
7
Internal Revenue Service. IRM Part 4 – Certain Technical Issues
8
Internal Revenue Service. Tax Topic 453 – Bad Debt Deduction
9
Internal Revenue Service. Debt-Equity Issue Analysis Factors
10
eCFR. 26 CFR Part 1 – Definition of Gross Income, Adjusted Gross Income, and Taxable Income
11
Internal Revenue Service. Instructions for Form 1120 – U.S. Corporation Income Tax Return