Does your company need a quick cash transfusion to keep operating on all cylinders? This could be a problem if the company owes you money for a prior debt.
Strategy: Forgive the debt and treat it as a “capital contribution” to your corporation. If you handle things properly, neither you nor the corporation has to pay any tax on the transaction.
Normally, forgiveness of a debt results in taxable income to the corporation, called cancellation-of-debt (COD) income. But a loophole in the tax law allows your company to effectively sidestep COD income when you forgive debt the company owes you.
Example: Let’s say your company incurs $100,000 of debt from a creditor. After it pays $25,000 of the debt, it begins experiencing financial difficulties. So it negotiates with the creditor to forgive the remaining $75,000 of debt in exchange for $50,000 of common voting stock. Under these facts, your company would be facing $25,000 of COD income ($75,000 – $50,000).
But you can create a different result if the company borrows the money from you or another shareholder. In other words, if you simply contribute the debt to the capital structure of the corporation without receiving any stock in exchange, the company incurs zero COD income.
Caution: Don’t take any additional corporate stock in exchange for forgiving the corporate debt. That could trigger taxable COD income for your corporation.
Furthermore, there’s no real reason to take it back if you’re the sole owner of the company. Because you already own all the outstanding shares, you’re in the same position ownership-wise as you were before the forgiveness of debt. Bottom line: You can avoid unnecessary tax by simply doing nothing.
Tip: This is a highly technical area of the tax law. Obtain expert advice.