Opportunity

Discussion in 'Growing and Managing a Business' started by mega129, Aug 23, 2013.

  1. mega129

    mega129
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    Hello

    I am considering an offer from a family friend to invest in their small business for a guaranteed return that is very attractive compared to the anemic rates banks offer these days.

    Assumptions (so we keep advice tuned to what I'm looking for, rather than get side-tracked)

    - Location: USA
    - We're not talking about a million bucks here, nowhere near that
    - I have a full-time job, and not gambling away all my savings
    - I understand the risk involved and have decided to go ahead with the investment (hey, it's my money, right :) )

    My question is how do I go about doing this for tax purposes?

    I have never owned a business, so I have no clue on where to start.

    I am not in any partnership or association with this friend. He would presumably send me checks every few months which I'm thinking of pushing into a regular savings account of some sort.
    But no idea beyond that.

    Would I have to set up some kind of company or corporation?

    Any advice is much appreciated.
     
  2. sjzllc00

    sjzllc00
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    How could you know how much profit they make every year.
    How you know how is it well or bad about their buisness?
    Risk is much than the profit you got.
     
  3. ArcSine

    ArcSine
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    With all your stated assumptions as given, the easiest way to structure the arrangement is as a loan. Your friend's periodic payments to you could either be interest only, or consist of both interest and a principal pay-down element. You've got flexibility to structure the repayment terms in a manner that fits both your needs and the company's cash flow pattern. For example, you might want to do interest-only payments for some X months or years, and then have the note amortize (eventually pay down to zero) over some number of months or years by having the periodic payments include a principal component in addition to the interest.

    No corporation set-up required on your part, nor any other type of entity. You're simply holding an IOU on which you're getting interest income. For tax purposes you'll report the interest income on Schedule B of your federal return.

    If you take this route make sure to create a written promissory note describing the terms of the deal, because
    1. Three years from now when your memory is that the note is to convert from a fixed-rate deal to a prime-plus floater, it's a safe bet your friend's recollection of the original agreement will differ.
    2. Absent a written promissory note, the IRS may assert that your investment was not a loan at all, but rather an equity investment in the company. If their assertion sticks it could have adverse tax consequences (since you haven't been treating the deal as an equity investment on your tax return all along).
    On that latter point, it's important to not only have a written note, but for both parties to actually act in compliance with its agreed-upon terms. For example, if the note provides for monthly payments, but in reality you've just allowed the friend to make payments in a haphazard, "pay me whenever you want" manner, you've given IRS grounds for disregarding the existence of the written note, and deeming your investment to be equity rather than debt.
     
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  4. mega129

    mega129
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    Thank you so much ArcSine for the valuable and sound advice. Exactly what I was looking for. Much appreciated.
     
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  5. ArcSine

    ArcSine
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    Happy to help. Cheers!
     

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