Starting a business often means getting creative about funding. You tap your savings, credit cards, SBA loans, and sometimes, a well-meaning family member who says, “If you need help, just let me know.”

Before you say yes or no, it’s worth slowing down and thinking through what accepting startup funds from family really means for your business, your taxes, and your relationships. While this arrangement can work beautifully, it can also get awkward or even downright messy. Let’s walk through your options.

Should You Take Startup Money from Family?

Short answer: maybe. Longer answer: it depends on how it’s structured and how clearly everyone understands the arrangement.

Family funding can be a great way to get a business off the ground, especially if traditional lenders aren’t an option yet. But mixing money and family requires extra care. Thanksgiving dinners have been ruined over less.

The two most common ways family members fund a startup are equity ownership (they become owners) or a loan (they expect repayment). Each comes with pros, cons, and tax implications.

Option 1: Make a Family Member an Equity Owner

When you make your family member an equity owner, they’re not just helping you out. They actually own a stake in the business. In a partnership or multi-member LLC, they become a partner. In a corporation, they become a shareholder.

Benefits of equity ownership:

• No immediate repayment pressure. You’re not making monthly loan payments while trying to keep the lights on.
• Shared risk. If the business struggles, you’re not the only one absorbing the loss.
• They may bring experience or connections. Sometimes Aunt Linda knows everyone in town.

Downsides of equity ownership:

• You’re giving up control. Ownership usually means voting rights or influence.
• Harder to unwind later. Buying someone out can be expensive and emotional.
• Expectations can get fuzzy. Is this a “silent partner” or someone who wants weekly updates?

Another consideration is the tax implications for the family member. Equity owners in a pass-through business, such as a partnership, LLC, or S corporation, receive a Schedule K-1 each year showing their share of the business’s profit or loss. This means they could owe taxes on business profits even if they don’t receive cash.

This can come as a surprise when the business reinvests profits, but the partner must still pay taxes on their share. A well-intentioned parent may not expect a tax bill tied to a company they’re not actively involved in.

Before bringing in a family member as an owner, make sure you both understand this part clearly. Ideally, you’ll have a signed partnership agreement outlining how you’ll allocate profits and losses.

Option 2: Treat Family Funding as a Loan

Instead of ownership, your family member acts like a lender. You keep control of the business, and they get repaid over time.

Benefits of a loan:

• You keep ownership and decision-making power.
• Cleaner boundaries. You owe payments, not explanations for every business decision.
• Easier exit. Once you pay off the loan, the family member has no ties to the business.

Downsides of a loan:

• Repayment pressure. Even family members usually expect repayment.
• Missed payments can still strain relationships. Awkward money conversations don’t disappear just because you share DNA.
• IRS scrutiny. A family loan can lead to unexpected taxable income, gift tax consequences, or both.

To keep the IRS happy (and avoid misunderstandings later), family loans need to look like real loans, not “wink-wink” gifts. That means you should have a written promissory note, a stated interest rate (at least the IRS minimum, called the Applicable Federal Rate), and a repayment schedule.

The family member must report the interest income on their tax return, and you can typically deduct the interest as a business expense.

If you don’t follow these steps, the IRS can do two things. First, if you don’t charge at least the appropriate applicable federal rate (AFR), the IRS can consider the difference between the AFR and the actual interest charged (even if it’s zero) as “imputed interest.” The lender is liable for the income tax on that imputed interest, even if you never paid a nickel. The IRS can also decide to treat the loan as a gift.

Next, we’ll look at how these consequences might play out in the real world.

Tax Consequences of a Family Loan: An Example

So, let’s say you borrow $50,000 from your father, and that AFR at the time of the loan is 4%. You had a written promissory note, but it didn’t address an interest rate, and you never made any payments. Three years later, the IRS audits your return and notes the loan on the books, but sees you’ve never claimed any interest expense deductions.

Now, the auditor decides to take a closer look at your father’s tax return for the past three years and sees that your father never claimed any interest income from the loan.

The IRS can decide to audit your father’s return, charge back taxes on the $2,000 of interest that should have applied to the loan for the past three years ($50,000 x 4%), and impose penalties for all three years.

Now, let’s say you don’t have a promissory note. In that case, the IRS will likely treat the $50,000 as a gift. In that case, it will decide that your father should have filed a gift tax return in the year your father gave you the money. This can create gift tax filing issues for your family member.

Is Equity or a Loan Right for You?

Ask yourself (and your family member) a few honest questions:

• Do they want involvement or just repayment?
• Are they comfortable with tax complexity and risk?
• Would disagreements about money spill into family gatherings?
• Do you want a long-term business partner or a short-term cash flow boost?

There’s no “right” answer. The best structure is the one everyone fully understands and agrees to before the money changes hands.

Remember, good intentions don’t replace good documentation. Whether you choose equity or a loan, put it in writing, set expectations early, talk through the tax impact upfront, and work with a tax advisor or attorney who can explain things in plain language.

That small step can protect your business and your relationships.

If you’d like help thinking through whether a family loan or ownership structure makes sense for your situation, contact NewWay Accounting. That’s exactly the kind of conversation we can help you navigate.