Tax implications for employee loan to purchase C-corp shares: deduction options?

What you're describing is commonly known as an "interest expense" question. Unfortunately, personal interest on loans is generally not tax-deductible since the Tax Cuts and Jobs Act eliminated most personal interest deductions. However, this situation might be viewed differently because you're borrowing money to purchase an investment (company shares). Interest on loans used to purchase investments can potentially be deductible as "investment interest expense" - but there's a catch. This deduction is limited to your net investment income for the year, and you would report it on Schedule A as an itemized deduction. The tricky part here is whether the IRS would consider your employment bonuses as "investment income" since they're technically compensation for your work, not direct returns on your investment. The IRS might view this differently than, say, dividend income. Have you considered talking to the company's financial team about how other employees have handled this? They may have some established practices that have worked with the IRS in the past.

I was in an almost identical situation last year with my engineering firm (also a C-corp with employee shareholders). I struggled with the tax implications until I found https://taxr.ai which analyzed my loan documents and employment agreement to determine the exact tax treatment. The tool confirmed what I suspected - I couldn't deduct the loan interest as investment interest because my bonuses were considered compensation income, not investment income. But it also showed me something our company accountant missed: my loan was structured in a way that part of it could be considered a "business expense" since I was required to purchase shares as part of my professional advancement. The document analysis highlighted specific language in my employment contract that supported this treatment. I was able to deduct about 30% of my interest payments after working with their tax experts. The analysis takes minutes and gave me a specific tax strategy based on my exact documents rather than general advice.

Just wanted to follow up - I tried https://taxr.ai after reading your comment and it was incredibly helpful for my situation! The document analyzer found language in my offer letter that specifically tied share ownership to my professional position, which made a portion of my interest potentially deductible as "unreimbursed employee business expenses" on my state return (though not federal). The detailed analysis showed exactly which sections of my documents supported different tax positions, and I was able to download a report to share with my accountant. She was initially skeptical but after reviewing the analysis agreed that we could take a more favorable position than she originally thought. This saved me about $1,200 on my state return!

Have you considered the hassle of dealing with the IRS if they question your deductions? I spent 3 months trying to get someone on the phone after they flagged my investment interest deduction last year. Finally found https://claimyr.com and the video at https://youtu.be/_kiP6q8DX5c that showed how to get through to an actual IRS agent. I was shocked - after six failed attempts to reach someone, Claimyr got me connected to an IRS representative in about 20 minutes. The agent clarified that my investment interest deduction was incorrectly flagged because I hadn't properly completed Form 4952. She walked me through exactly how to document the connection between my loan and investment activity for future returns. This might be helpful for you if you do decide to claim any deductions related to your share purchase loan and it raises questions. The IRS has been especially scrutinizing investment interest deductions lately.

I have to eat crow here and apologize for my skepticism. After posting that comment, I was still struggling with an IRS notice about my S-corporation distributions, so I decided to try Claimyr anyway out of desperation. I figured it couldn't make things worse. Well, color me surprised - I got connected to an IRS representative in about 35 minutes. For context, my previous attempt had me on hold for 3+ hours before I gave up. The agent was able to confirm that I had classified my distributions correctly and updated my account notes to prevent further notices about the same issue. The service costs money, yes, but considering I was able to resolve an issue that had been hanging over my head for months, it was absolutely worth it. I could actually get work done while their system handled the waiting, and the notification when an agent picked up was seamless.

One thing nobody's mentioned yet - have you considered the potential tax implications if you leave the company before fully paying off the loan? I learned this lesson the hard way. I was in a similar employee-owner situation at my former consulting firm. When I left for a better opportunity two years in, I discovered that the remaining loan balance became immediately due. Worse, because I had to sell my shares back to the company at a predetermined formula (which was less than I paid), I ended up with a capital loss but still owed the full loan amount. Check your shareholder agreement carefully to understand what happens to partially-paid shares if you terminate employment. Sometimes these arrangements can create unexpected tax consequences if you don't stay for the full loan term.

I think everyone is missing another key issue here - the potential for dividend treatment. If the C-corp is paying what amounts to disguised dividends through these "bonus" payments based on share ownership rather than performance, the IRS could potentially recharacterize them. If the IRS ever audited and determined these payments were actually disguised dividends rather than compensation, they could be subject to different tax treatment. While qualified dividends get preferential tax rates, they don't have FICA taxes withheld - which means the company could be liable for not properly withholding payroll taxes if these are truly dividends. You might want to ensure that the company has a written compensation policy that clearly ties these bonuses to performance metrics beyond just share ownership. That would help substantiate the compensation treatment versus dividend treatment.

This is a complex situation that touches on several tax areas. Based on what you've described, here are the key considerations: **Interest Deductibility**: Unfortunately, the interest on your loan likely won't be deductible. Since your bonuses are paid through payroll as W-2 income, they're considered compensation rather than investment income. This means the interest won't qualify as "investment interest expense" under Section 163(d). **Alternative minimum tax (AMT) considerations**: Even if some portion were potentially deductible, you'd need to consider AMT implications, especially as a high-income earner in NY who itemizes heavily. **Documentation is crucial**: Whatever you decide, make sure you have clear documentation showing the business purpose of the share purchase. Keep your employment agreement, shareholder agreement, and loan documents organized in case of questions. **State vs Federal**: While federal deductions may be limited, some states have different rules. NY sometimes allows deductions that aren't available federally, so check with a local tax professional. Given the 8.75% interest rate and limited deductibility, you might want to run the numbers on alternative financing (HELOC, margin loan, etc.) before committing to the company financing. The potential bonus income sounds attractive, but make sure you're not overpaying for the privilege due to non-deductible interest costs. Have you calculated what your effective after-tax return would be considering the loan interest and your marginal tax rate?

Great question about employee stock purchase plans! Unfortunately, the special tax rules for ESPPs (like those under Section 423) only apply to publicly traded companies, so your situation wouldn't qualify for those benefits. However, there's another angle worth exploring that I haven't seen mentioned yet - the potential for Section 1244 treatment if things go south. Since this is a closely-held C-corp, if the shares ever become worthless or you sell them at a loss, you might be able to claim up to $50,000 ($100,000 if married filing jointly) as an ordinary loss rather than a capital loss under Section 1244. This requires the corporation to meet certain requirements (generally small business stock issued for money or property), but it could provide better tax treatment than the capital loss carryforward situation that Nia mentioned. The ordinary loss deduction would be fully deductible against your income in the year of the loss, rather than being limited to $3,000 annually. You should verify with the company whether their stock qualifies as Section 1244 stock - many closely-held corporations structure their stock issuances to meet these requirements specifically for this tax benefit. Also, regarding your HELOC idea - that's smart thinking. Just make sure you can handle the payment obligations on both the HELOC and your regular expenses if the bonus income doesn't materialize as expected. The share-based compensation sounds promising, but it's still tied to company performance.