Tax Treatment of Funding in a Corporation

Tax Treatment of Funding in a Corporation

Despite being the most ignored and overlooked entities, The C Corporation is a legal entity that has great tax preparation Tampa benefits for organizations and businesses. This article enlightens you how to benefit from it and deal with shareholders contribution a business or corporation.

Capital Contributions

There are various ways in which corporations can receive money from their shareholders; it could be either in exchange of stock or by paying an extra price for the existing stock. The organisation does not experience loss or gain when a certain amount of money or a kind of property is received in exchange for stock. Also, the gross income of any particular organisation does not take into account the contributions of the shareholders.

Similarly, extra capital received as pro rate transfers does not count in increasing the income of the corporation. The contributions of the corporation show an additional price paid for the existing shares when the shareholders are elected to gain additional funds without exchange in the stock.

Basis of capital contributions

The basis of capital contributions of an organisation works in a simple way. It is the same when property is gained from a particular shareholder to represent capital contribution as the basis of the property back when it was under the ownership of the shareholder.

Debt funding in a corporation

There are times when shareholders do not contribute their capital as equity instead they fund the business with debt. In case the debt is a tool of funding, effort has to be made to ensure that the document the agreement. Similar to the process of equity funding, debt funding cannot be counted as the corporation’s income. However, there is an advantage that debt has over stock, which is the interest on debt that can be deducted by the organisation, whereas the dividend payments cannot be.

On the other hand, on the shareholder’s perspective, the loan payments are not considered taxable for shareholders until the payment of the loan exceeds the basis. Moreover, the dividends have a lower tax rate as compared to other payments that involve interest. In this case accountant Tampa can also help you out so consult one.

Reclassification of debt as equity

The IRS of a corporation can be re-categorized debt as equity if the corporation is thinly capitalized. There is a particular U.S. Code § 385 for the treatment of specific interests in organizations as stock or indebtedness lists numerousaspects that can be used to conclude whether a debtor creditor relationship exists or not. Some considerable aspects include:

  • Is the debt instrument in appropriate form?
  • Is there anequitable rate of interest?
  • Is the debt paid on a timely basis?
  • Are debt payments determined on the basis of earnings?
  • Is the debt treated in the same way as the other debt in the corporation?

To conclude, debt and equity are two different procedures used to fund a corporation. However, there is no denying the fact that the equity investor has greater risk and also there is no guarantee that they will ever get their entire investment back. Moreover, the equity investor is also the last one to get paid incase the business fails, which is another great risk of being the equity investor. Debt funding might has a set of its own risks but it is definitely less risky than equity investors.