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The best policy and checklist to follow is to find out their needs for borrowing, formalize your agreement to protect your business, have the employee sign a Promissory Note, keep pristine records of the agreement, and charge an interest rate of at least the Applicable Federal Rate if the loan is more than $10,000.
Everyone knows that small business owners wear many hats—but most people don’t think that includes acting as a lender.
But if one of your employees asks for a loan, should you do it? And if you do loan a staff member money, how can you do it responsibly? Here are a few things to think about if you’re considering employee loans.
Giving employee loans might actually have some benefits for your business:
It could be easier to decide to lend staff money if you have just a few employees that you know well, too.
Unfortunately, not all employer loan stories end well. Some of the problems you may run into include:
If you don’t want to lend money from your business, there may be a few alternatives that could help your employee when they need to borrow money.
Chances are good that if your employee is asking you for a loan, they’re desperate. Maybe they’re faced with unexpected car repairs, medical bills for a family member, or even something like a surprise furnace replacement.
If that’s the case, a paycheck advance could be the answer. Historically, people in financial trouble would turn to their bosses for an advance on their paycheck, but according to a recent Society for Human Resource Management survey 2015 Employee Benefits: A Research Report, but this is becoming less common. Between 2011 and 2013, payroll advances by companies decreased from 21% to just 13%.
However, by giving your employee some or all of their next paycheck early, you limit your business’s potential loss to the amount of one paycheck, and it’s a simpler solution than a formal employee loan.
Does your business offer 401(k) plans to your employees? If so, check into whether the plan is a “qualified plan” that might let participants borrow against their holdings. According to the IRS, in a qualified plan, “the maximum amount that the plan can permit as a loan is (1) the greater of $10,000 or 50% of your vested account balance, or (2) $50,000, whichever is less.”
If you do decide to offer loana, it’s important to remember these 5 points to make sure everything goes as smoothly as possible.
Ask your employee why they need the loan. Borrowing money for a one-time unexpected or emergency expense in one thing, but constant overspending and living without a budget may lead to a long road of being pestered to borrow more money.
Formalize your lending arrangements to protect your business. Establish guidelines for your employee lending program, because chances are that if one employee gets a loan from you, others will ask.
Have your employee sign a Promissory Note. Include the loan’s details—like total amount—and repayment terms—like payment amount, payment frequency, interest rate, and what happens in case of default.
Make sure that any loans from your business are recorded “on the books” so loan payments made by your employee aren’t mistakenly identified as business income.
If the employee loan given by your business is over $10,000, charge an interest rate of at least the Applicable Federal Rate (or AFR). This interest rate gets set by the IRS each month. If you don’t charge this interest rate, the IRS could consider your business as having received “phantom income,” which is taxable.
Small business owners often think of their employees as extended family members, and it’s hard not to sympathize when a family member struggles financially. Only you can decide whether it’s wise to lend money to your employees.
Whatever you choose to do, think carefully about how your actions will impact your business, your employee, and the morale and work environment of your entire organization.