USA Promissory Notes, Interest Income, & Non-monetary Investments

[digital_monk_13]

Hello! I'm new here. I couldn't decide if this best fit in the general or the individual section, so hopefully I posted appropriately.

I am interested in investing in small local startups (think catering, computer service/repair, web design, etc.). I'm interested in using promissory notes as a tool for gaining a return from the startup owners, but in terms of taxes, I would like to treat it as just a personal investment and avoid creating a business around it (no Schedule C, SE, etc.). I've thought about not only investing money, but also offering assistance to the startup by getting them connected with the right people, helping them develop their business plan, creating forms, and providing general or specific business knowledge. My Questions are:

1) Can I treat the aforementioned non-monetary contributions as part of the investment and avoid "operating as a business." In otherwords, are these services considered business activity, solely investment activity, or is the discretion mine?

2) If considered investment activity, how would the return on such an investment be taxed. For example, if the return is y%, do I just claim interest income on my taxes for y% of (monetary investment + declared value of services)?

Thank you very much for any help you can provide,
Monk

 

[kirby]

1. Non monetary of course means no bucks involved. So I take it that this refers to your personal assistance to the start-up. If you are not being paid for this assistance by the start up there is no related income tax.(cause there is no income on this!)

2. If you are not being paid by the start up then your only tax is on the interest income. You do not get to deduct the value of your unpaid services to the startup.

Other items;

In California (for example) , if you make more than one loan in a 12 month period then you must be licensed under the Finance Lenders law. So you need to see if a similar law applies in your case.

You mention using a promissory note. That has NO collateral to back it up in case of default. So you might want to consider making collateralized loans instead.

 

[digital_monk_13]

Thanks for your response. I hadn't thought much about the potential license requirement - I'll look into that! The rest is starting to make sense, but is still a little fuzzy for me. Let me give a hypothetical situation:

Lets say I want to invest the following into a new startup called "ABC":
- $5000 cash
- Personal assistance that ABC and I both agree would be valued at $5000

Can a promissory note or contract be written for this situation such that ABC needs to pay back $10000 + y% interest?

If not, does anyone know of other alternatives that would be treated as investment activity rather than business activity?

Thanks for your help with this!

 

[kirby]

Just because your fee for professional services is paid through a promissory note does not make that payment into investment income. (Just as paying your fee in gold does not make you a pirate! Your $5,000 for "personal assistance" is just professional fee income to you.

I don't know of anything that will change that.