Small business owners have a variety of withdrawal methods available to them when attempting to minimize the amount of vulnerable assets within the business. Taking payments for loans and leases is one possible strategy that can accomplish this goal, subject to certain tax issues.
Self-employment tax regulations exempt payment for loans and leases, where the recipient is not in the regular business of extending loans or leasing property. Small business owners should always check with a tax advisor before assuming this will be the outcome under the particular circumstances.
In addition, because these distributions are for return value (similar to payments for salary), they are not subject to the Uniform Fraudulent Transfers Act's constructive fraud provisions.
Moreover, these distributions aren't made to owners on account of their ownership interests (again, similar to salary). Thus, the distributions also are not subject to the constructive fraud restrictions imposed by state corporation and LLC statutes.
However, in contrast to payments for salary, these distributions also avoid the self-employment tax.
In short, this alternative offers the ability to withdraw funds in a way that avoids both the self-employment tax and the onerous constructive fraud restrictions. Further, strategically funding the business entity with loans and leases using operating and holding companies is a significant asset protection strategy.
The use of this type of debt funding ensures that assets contributed by owners to the entity will not be vulnerable to the claims of the business's creditors. Thus, the use of loans and leases should be a first-line withdrawal strategy.
This strategy applies not only to the corporation, but to the limited liability company (LLC) as well.