Most owners of multiple entities assume moving cash between their own companies is free money with no tax consequences. That belief is exactly what turns a routine transfer into a reclassified dividend, a disallowed deduction, or a payroll tax surprise. When you have a C corp loaning money to a S corp, the transaction is only as clean as the paperwork behind it, and the IRS treats sloppy intercompany lending as a dividend or a disguised distribution the moment it smells like a shortcut.

Here is the contrarian truth: an intercompany loan done right is one of the most powerful and underused cash management tools a multi-entity owner has. Done wrong, it is an audit magnet. This guide walks through exactly how to structure, document, and defend a loan between a C corporation and an S corporation, with real dollar figures, the IRS rules that govern it, and the mistakes that cost owners thousands.

Quick Answer: Can a C Corp Legally Loan Money to an S Corp?

Yes. A C corporation can loan money to an S corporation, even when both are owned by the same person, as long as the loan is a bona fide debt. That means a signed promissory note, a market interest rate, a repayment schedule, and actual repayments. Without those elements, the IRS can recharacterize the transfer as a dividend from the C corp or an equity contribution, triggering taxes neither party planned for. The structure is legal; the execution is what gets scrutinized.

Why a C Corp Loaning Money to an S Corp Makes Strategic Sense

When you control both entities, cash often sits in the wrong place. A profitable C corp might be holding retained earnings while your S corp needs working capital for inventory, equipment, or payroll. Pulling that cash out as a dividend means the C corp pays 21 percent corporate tax, then you pay another layer of tax on the dividend personally. That double taxation can push the effective rate north of 36 percent before the cash ever reaches the S corp.

A properly structured loan sidesteps that. The C corp lends the money, the S corp uses it, and the only taxable event is the interest income the C corp reports, offset by the interest expense the S corp deducts. For many business owners running multiple entities, this is the difference between deploying $100,000 of working capital and only seeing $64,000 of it survive the tax gauntlet.

Common Scenarios Where This Strategy Shines

• Working capital gaps: The S corp needs cash for a seasonal inventory build and the C corp has idle reserves.
• Equipment purchases: The S corp buys machinery but wants to preserve its bank credit line.
• Expansion funding: The S corp opens a second location and borrows from the C corp instead of a commercial lender at higher rates.
• Bridge financing: The S corp waits on a receivable and uses a short-term intercompany loan to cover payroll.

In each case, the economics only work if the loan holds up under IRS scrutiny. That is where most owners lose the benefit.

What Makes a Loan Bona Fide in the Eyes of the IRS

The IRS does not care what you call the transfer. It cares whether the substance matches the label. Courts and the IRS apply a multi-factor test to decide whether a transfer between related entities is genuine debt or a disguised distribution. Miss too many factors and your loan gets reclassified.

The Seven Factors That Determine Debt vs. Equity

1. A written promissory note. This is non-negotiable. A note states the principal, interest rate, maturity date, and repayment terms.
2. A fixed maturity date. Open-ended “loans” with no due date look like equity contributions.
3. A market interest rate. The rate must meet or exceed the applicable federal rate (AFR) published monthly by the IRS.
4. A repayment schedule and actual repayments. If no payments ever occur, the IRS treats it as a gift or dividend.
5. Adequate capitalization of the borrower. If the S corp is thinly capitalized and could never realistically repay, the loan smells like equity.
6. Enforcement of terms. A real lender enforces default provisions. A related-party lender should too.
7. Treatment on the books. Both entities must record the transaction as a loan, with a note receivable on the C corp side and a note payable on the S corp side.

According to IRS guidance on related-party debt, no single factor is decisive, but the absence of a written note and a market rate are the two fastest ways to lose. The applicable federal rate is published in a monthly IRS revenue ruling, and for intercompany loans you want to document which AFR you used and when.

Setting the Interest Rate Correctly

The AFR comes in three terms: short-term for loans of three years or less, mid-term for three to nine years, and long-term for loans over nine years. For a five-year intercompany loan originated when the mid-term AFR sits around 4.2 percent, charging anything below that rate exposes you to imputed interest rules under Section 7872. The IRS will treat the foregone interest as if it were paid, creating phantom income for the lender and a potential dividend for the borrower.

Pro Tip: Lock the rate at origination, cite the specific revenue ruling and month in your note, and never let a related-party loan sit at zero percent. The few hundred dollars of documented interest protect tens of thousands in potential reclassification exposure.

KDA Case Study: Multi-Entity Owner Saves $19,400 With a Clean Intercompany Loan

Daniel runs two companies in California. His consulting firm is a C corporation that had accumulated $240,000 in retained earnings. His product company, an S corporation, needed $120,000 to fund a large inventory order for the holiday season. His first instinct was to pull a dividend from the C corp and inject the cash into the S corp.

Running the numbers, that dividend route would have cost him roughly $22,800 in combined federal and California personal tax on the distribution, on top of the corporate tax the C corp had already paid. The cash would have arrived at the S corp heavily diminished, and he would have lost flexibility for future transfers.

KDA restructured the transfer as a bona fide loan. We drafted a promissory note with a 36-month term, set the interest rate at the mid-term AFR of 4.2 percent, built a monthly repayment schedule, and recorded a note receivable on the C corp books and a note payable on the S corp books. The C corp now reports about $7,600 in interest income over the life of the loan, and the S corp deducts that same interest as a business expense, nearly washing out at the entity level.

The net result: Daniel moved the full $120,000 of working capital without triggering a dividend, preserved his C corp earnings strategy, and saved approximately $19,400 in the first year compared to the distribution approach. He paid KDA $3,200 for the structuring and documentation work, a first-year return of roughly 6x. More importantly, the loan file is airtight if the IRS ever asks.

Ready to see how we can help you? Explore more success stories on our case studies page to discover proven strategies that have saved our clients thousands in taxes.

Step-by-Step: How to Document a C Corp to S Corp Loan

The strategy lives or dies on documentation. Here is the exact sequence we use with multi-entity clients who want the loan to survive an audit.

1. Draft a promissory note. Include principal amount, interest rate tied to the current AFR, maturity date, repayment frequency, and default provisions. Have an authorized officer of each entity sign.
2. Authorize the loan with corporate resolutions. Both the C corp board and the S corp management should pass written resolutions approving the transaction. This proves arm’s-length intent.
3. Record the AFR source. Note the specific IRS revenue ruling and month you used to set the rate. Keep a copy in the loan file.
4. Book it correctly. Enter a note receivable on the C corp general ledger and a matching note payable on the S corp ledger. Your bookkeeping and payroll services provider should segregate these from operating accounts.
5. Make and track repayments. Set up recurring transfers that match the schedule. Each payment should split between principal and interest and be recorded on both sets of books.
6. Report interest on both returns. The C corp reports interest income; the S corp deducts interest expense. Keep the amounts reconciled year over year.

Follow this sequence and the loan has every hallmark of bona fide debt. Skip steps and you hand the IRS the argument that the transfer was really a dividend.

Common Mistake That Triggers a Reclassification

The single most common error we see is the “handshake loan.” The owner transfers cash from the C corp to the S corp, makes a memo in QuickBooks that says “loan,” and never creates a note, never sets a rate, and never repays a dime. On paper it looks like debt. In substance it is a distribution.

When the IRS examines this, it collapses the fiction. The transfer becomes a taxable dividend from the C corp to the shareholder, then a capital contribution to the S corp. The shareholder now owes tax on a dividend they never intended to take, often with penalties and interest stacked on top. A $120,000 transfer can generate a surprise tax bill of $20,000 or more plus accuracy-related penalties.

Red Flag Alert: If your intercompany “loan” has no note, no interest, no maturity date, and no repayment history, it is not a loan. Fix it before year-end by papering the transaction properly or converting it to a documented distribution so at least the tax treatment is intentional.

Do I Have to Charge Interest on an Intercompany Loan?

Yes, if you want the loan respected. Section 7872 governs below-market loans, and when a lender charges less than the AFR, the IRS imputes the foregone interest. For a C corp loaning money to a shareholder-controlled S corp, that imputed interest can be treated as a dividend to the shareholder, defeating the entire purpose of the structure.

There is a de minimis exception for loans of $10,000 or less that are not tied to income-producing assets, but most meaningful intercompany loans blow through that threshold immediately. For any loan of real size, charge at least the AFR and document it. The interest income and expense largely offset between your two entities, so the net cost is minimal while the protection is substantial.

What If the S Corp Can’t Repay the Loan?

This is where thin capitalization becomes a problem. If the S corp was never positioned to repay, the IRS argues the loan was equity from day one. To avoid this, the S corp should have a realistic ability to service the debt from its own cash flow at the time of origination.

If circumstances change and the S corp genuinely cannot repay, do not simply let the balance sit forgotten. Options include refinancing with a longer term, converting a portion to a documented capital contribution, or formally restructuring the note. Each of these has tax consequences, but handling them deliberately beats letting the loan quietly decay into a reclassification waiting to happen. For owners with layered structures, our premium advisory services map the cleanest path through these decisions.

How Does an Intercompany Loan Affect S Corp Basis?

This is a subtle but important point. A loan from a C corp to an S corp does not increase the shareholder’s basis in the S corp. Only loans made directly by the shareholder to the S corp create debt basis. Many owners confuse the two and assume any cash flowing into the S corp boosts their ability to deduct losses. It does not when the lender is a separate entity.

If your goal is to create debt basis so you can deduct S corp losses, the loan must come from you personally, not from your C corp. Structuring this wrong means losses get suspended and deferred, locking up deductions you were counting on. Plan the lender relationship around your basis strategy, not just your cash needs.

Federal vs. California Treatment

California generally conforms to the federal characterization of debt versus equity, but California also imposes its own entity-level taxes and fees. An S corp in California pays the 1.5 percent franchise tax on net income plus the annual minimum, and a C corp faces the 8.84 percent state corporate rate. The interest income and expense flow through those state calculations as well, so model both the federal and California impact before setting the loan size and rate. This information is current as of 10/1/2026. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.

Frequently Asked Questions

Can the same person own both the C corp and the S corp lending to each other?

Yes. Common ownership is allowed and extremely common. The key is that because the entities are related, the IRS scrutinizes the loan more closely. Bona fide documentation, a market rate, and actual repayments are what separate a respected loan from a reclassified distribution.

What interest rate should I use for a related-party loan?

Use at least the applicable federal rate for the loan’s term as published in the monthly IRS revenue ruling. Charging below the AFR triggers imputed interest under Section 7872. Document the specific rate and the month you pulled it from.

Does the C corp pay tax on the interest it receives?

Yes. The interest the C corp receives is taxable income at the corporate level. The offsetting benefit is that the S corp deducts the same interest as a business expense, so between your two entities the net tax impact of the interest is usually small.

What happens if I never put the loan in writing?

An undocumented transfer is the easiest thing for the IRS to recharacterize. Without a note, rate, and repayment history, the transfer is likely treated as a dividend from the C corp, creating personal tax liability and penalties. Paper every intercompany loan before year-end.

The Bottom Line on Intercompany Lending

A loan between your C corp and your S corp is a legitimate, powerful way to move capital where it is needed without the double tax of a dividend. But the strategy is only as strong as the file behind it. A signed note, a market interest rate, a repayment schedule, and clean bookkeeping are the difference between a tool that saves you thousands and a transfer that detonates into a surprise tax bill.

The IRS is not hiding the rules on intercompany loans. It is simply waiting to see whether you followed them. Build the file like a bank would, and the loan stands. Treat it like a handshake, and it collapses the moment anyone looks.

Book Your Multi-Entity Tax Strategy Session

If you are moving cash between a C corp and an S corp without a bulletproof loan file, you are one audit away from a reclassified dividend and a tax bill you never planned for. Let’s structure your intercompany lending the right way so every dollar works harder and nothing gets reclassified. Book a personalized consultation with our strategy team and walk away with a documented, audit-ready plan. Click here to book your consultation now.