Drawing on your own assets to fund your business

A surprising number of lawn care and landscaping business owners depend on themselves for their financing needs. With conventional financing increasingly more difficult to obtain, it is little wonder that self-financing is the number one form of financing used by small business owners. It’s quick, doesn’t require a lot of paperwork and is often less expensive than conventional financing.

That is not to say that self-financing is without a cost. The cost that every turfgrass professional using their own funds must consider is the “lost opportunity” cost. The lost opportunity cost is the amount that could have, or might have, been earned had those funds remained in savings or invested elsewhere.

However, in the current economic climate, doing it yourself or keeping financing within the family frequently produces the fastest and best results. Unfortunately, our tax laws create a number of obstacles that must be overcome to avoid penalties and corresponding higher tax bills.

Reversing the bottomless pit

A turfgrass professional using their own money will usually discover that there is more than they think. Although many business owners ordinarily think only of cash savings, there are other assets that can be liquidated and turned into cash. Unfortunately, there are also many drawbacks, including the risk of running afoul of our tax laws and the Internal Revenue Service.

When John Jones’ lawn care business ran low on funds, things began to look grim. Conventional lenders repeatedly turned him down, and even nonconventional funding sources rejected his overtures. The answer was to personally guarantee a $100,000 loan, run up expenses on his personal credit card and defer his salary. In short, Jones put himself in a position where he had a lot to lose, and the only way out was to succeed and profit.

Putting yourself at risk can attract lenders or investors. Just as often, it succeeds in raising the funds needed by the business. Consider a few strategies that can put the owner at risk, provide the needed funding or both:

  • Liquidate savings. If you’ve got it, consider giving it up.
  • Take out a home equity loan. Remember, however, there is a limit to the amount of qualified residence interest that is tax-deductible. The aggregate amount of acquisition indebtedness may not exceed $1 million, and the aggregate amount of home equity indebtedness may not exceed $100,000; interest attributable to debt over these limits is nondeductible, personal interest.
  • Get a bank loan. Usually, any bank loan will require a personal guarantee or the guarantee of a friend or family member.
  • Sell a vacation home.
  • Take out a margin loan against your stock holdings.
  • Never use personal credit card debt for business purposes; it is far too costly in a variety of ways.

Imputed interest

When either lending to or borrowing from the business, remember that it must be a legitimate, interest-bearing loan. Under our tax rules, an owner borrowing from the business can face a hefty tax bill should the IRS view the transaction as a dividend payout rather than a loan.

Often, it is below-market interest rates or the lack of evidence of an arm’s-length transaction that draws the attention of the IRS. The IRS is particularly interested in gift loans; corporation-shareholder loans; compensation loans, between employer and employee or between independent contractor and client; and any below-market interest loan in which the interest arrangement has significant effect on either the lender’s or borrower’s tax liability.

If the IRS re-characterizes or relabels a transaction, the result is an interest expense deduction when none was previously claimed by the borrower and unexpected, taxable interest income on the lender’s tax bill. The lender’s higher tax bills, often dating back several years, are usually accompanied by penalties and interest on the underpaid amounts.

Always a borrower be

For many businesses, borrowing means a loan from the operation’s owner or shareholder. In some cases, the owner or shareholder borrows the funds from the operation. Loans and advances between so-called “related parties” are quite common in closely held businesses. Corporate loans to shareholders are probably the most commonly seen by IRS auditors, with advances from shareholders to the incorporated turfgrass operation running a close second, particularly in the early years of closely held, but thinly capitalized, corporations.

The IRS’s interest in these transactions stems from the potential for tax avoidance, whether inadvertent or intentional. When an incorporated business makes an interest-free (or low-interest) loan to its shareholder, in the eyes of the IRS, the shareholder is deemed to have received a nondeductible dividend equal to the amount of the foregone interest, and the corporation receives a like amount of interest income.

Fortunately, there is a $10,000 de minimis exception for compensation-related and corporate/shareholder loans that do not have tax avoidance as one of the principal purposes.

Although this transfer of taxable income between entities may appear to be offsetting, there can be a significant tax impact on the reallocation, depending on the relative tax benefits of the borrower and the lender and the deductibility of the expense deemed paid.

Downside: stock or loan

When IRS examiners review loans from shareholders and the common stock accounts of many small businesses, they frequently encounter “thin capitalization.” Thin capitalization occurs when there is little or no common stock and there is a large loan from the shareholder. Section 385 of the tax law specifically considers whether an ownership interest in a corporation is stock or indebtedness.

The objective of the IRS when they encounter thin capitalization is to convert a portion, if not all, of the loans from the shareholders into capital stock. Naturally, this conversion requires an adjustment to the interest expense account because, at this point, the loans are considered nonexistent. The interest paid by the incorporated business on these disallowed loans becomes a dividend at the shareholder level equal to the operation’s earnings and profits.

Loans gone bad

Under our tax laws, a business bad debt deduction is not available to shareholders who have advanced money to a corporation where those advances were labeled as contributions to capital. A business owner or shareholder who incurs a loss arising from his guaranty of a loan is, however, entitled to deduct that loss, but only if the guaranty arose out of his trade or business or in a transaction entered into for profit. If the guaranty relates to a trade or business, the resulting loss is an ordinary loss for a business bad debt.


If your business is in need of an infusion of cash, but you are reluctant to invest additional money, an answer may lie with the tax benefits. Are the tax benefits of the business being wasted because of low or nonexistent profits? And, as a result, does the business find itself in a low tax bracket?

A one-transaction-cures-all, all-purpose solution involves the sale-leaseback of the assets of your business. Generally, the business sells its assets—the building that houses the operation, the equipment used in that operation or even the vehicles so important to that business—and, in return, the business receives an infusion of working capital. The buyer of those assets, usually using borrowed funds, is often the operation’s owner or principal shareholder, you.

When the owners or principal shareholders in a business own the assets of the operation, the business pays fully tax-deductible lease payments for the right to use those assets in its operation. An unprofitable business is exchanging depreciable equipment or a building for badly needed capital and immediate deductions for the lease payments that it is required to make.

The new owner of that equipment, whether the business’ owner, chief shareholder or, perhaps, a trust established for the benefit of the owner’s children, will receive periodic lease payments. With one transaction, the owner has found a way to get money from the business without the double-tax bite imposed on dividends. More importantly, the operation has an infusion of cash.

Self-financing is the number-one form of financing used by small business owners. Among the advantages of self-financing is that control is not given to shareholders, nor will there be oversight by bankers or other lenders. Disadvantages are that sufficient capital may not be available.

Self-financing is an option, often the only option, for many turfgrass professionals in today’s economic climate. Drawing on assets such as savings accounts, equity in real estate, retirement accounts, vehicles, recreational equipment and collectibles, business owners are increasingly finding the funds needed for their operations.

Selling these assets for cash or using them as collateral for a loan are options. Other self-financing options are also available and should be investigated and considered by business owners in need of funding.

Mark E. Battersby is a frequent contributor to Turf, writing on financial and business matters. He resides in Ardmore, Pa.