Intercompany Charges and Agreements: Leases, Loans, and Services Between Your Entities

Once you own more than one entity, money and services move between them. An operating company pays rent to the property entity. A parent lends to a subsidiary. One company's staff does work for another. If none of it is written down, your structure exists only in the state filing office, and a lender, buyer, or court may treat the entities as one.

Why documentation matters

Liability separation. Courts look at whether entities act separately. Arm's-length paper helps show that they do.
Tax reasonableness. Payments between related parties are examined for whether they reflect real value. Unsupported charges can be recharacterized.
Diligence. Buyers and lenders ask for leases, loans, and service agreements. Missing documents slow deals and lower value.
Clarity among owners. If ownership differs across entities, agreements prevent disputes about who owes what.
Bookkeeping. Clear terms tell your bookkeeper how to code transactions.

Leases between entities

The classic case is an operating business renting from a property-holding entity owned by the same person.

Key points:

Use a written lease with the parties, premises, term, rent, escalations, expense responsibilities (triple net, gross, or modified), maintenance, insurance, and default terms.
Set rent at a reasonable market level. Use broker opinions, published comparable listings, or an appraiser's estimate. Record the sources.
Actually pay it. Rent that is accrued but unpaid for years is a warning sign.
Insure properly. The property entity should carry property and liability coverage. The tenant should name the landlord as additional insured.
Consider tax effects. Rent is generally deductible to the operating company and income to the property entity. If both are disregarded entities of the same individual, the net federal income tax effect may be neutral, but if one is an S-corp or a partnership, the flows matter. There is also an anti-abuse rule called self-rental that can change the character of rental income to nonpassive in some circumstances.

See owning your building in a separate LLC for the property structure.

Loans between entities and owners

Loans are common: a parent funds a subsidiary, an owner lends to the company, or a profitable entity lends to one with a cash shortage.

Elements of a solid loan record:

A promissory note signed by the borrower, stating the principal, interest rate, payment schedule, maturity, and any security.
A reasonable interest rate. Federal rules set minimum interest rates (applicable federal rates) for many related-party loans, and below-market loans can have imputed interest consequences. Ask an adviser about the current rates and their application.
Actual payments consistent with the note.
Correct bookkeeping as a liability of the borrower and an asset of the lender, not as income or expense.
Consideration of debt versus equity. A "loan" that will never be repaid may be treated as a capital contribution or distribution. For S-corps, shareholder loans have basis implications. See S-corp shareholder basis.

Service and management agreements

When one entity provides staff, administration, marketing, or leadership to another, write a services agreement.

Include:

A description of services.
Fee structure and payment timing.
Term and termination.
Who supervises and who controls the work.
Insurance and indemnities.
Confidentiality and intellectual property ownership.
What happens to work product on termination.

See management company structure.

Shared costs and cost allocation

Sometimes several entities share a vendor contract, office, or software subscription. Choose a fair allocation method (headcount, revenue, usage, floor space) and document it. Reallocate periodically, and keep the invoices with the allocation worksheet. Paying all shared costs from one entity and never reimbursing is an easy way to blur lines.

Intellectual property licenses

If one entity owns the brand, software, or trademarks and another uses them, use a license agreement. State the license scope, royalty or fee, quality control, term, and termination. Royalties should be reasonable relative to the value and use. Using a related-entity license to move income among taxpayers invites scrutiny. Also consider whether the arrangement changes the sale value of the business.

Guarantees and security

If one entity guarantees another's obligations or pledges assets, record it and think through the risk. A guarantee from a healthy entity for a struggling sibling undermines the separation you built.

Year-end reconciliation

Each year:

Reconcile intercompany receivable and payable balances between entities so both sides agree.
Confirm that rent, interest, and service fees were paid or properly accrued.
Review the agreements for needed updates (rent escalations, interest rate changes, scope changes).
Check that classifications match the tax positions on returns.
Save the signed agreements and supporting data with your tax records.

Common problems

No documents at all.
Templates copied from unrelated deals that do not fit.
Signature blocks that name the wrong entity or omit the signer's capacity.
Amounts that change to suit tax results rather than facts.
Undocumented transfers labeled "owner loan" in the books.
Charges without any invoices.
Accruals that never get paid.

Sales tax and other indirect taxes

Some intercompany charges can be subject to sales or use tax, depending on the state and the type of service or property. Leases of real property are treated differently in different jurisdictions, and some states tax commercial rent. Ask about local rules before finalizing the structure.

Making it routine

Use a checklist: agreement signed, fee documented, invoice issued, payment made, books reflect the transaction, and annual review complete. Assign one person to own the process. If you want help building the paper trail, AE Tax Advisors can coordinate the tax and bookkeeping side with your attorney, and a discovery call is the way to begin.