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Pump up your company’s net worth without a tax hit

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in Small Business Tax,Small Business Tax Deduction Strategies

Does your company need a quick capital transfusion to keep operating? If so, consider forgiving money the company owes you and treating it as a contribution to the corporation. Done properly, this is a tax-free transaction for you and the corporation.

Normally, debt forgiveness would result in cancellation-of-debt (COD) income to the corporation. But a loophole in the tax law allows your company to effectively sidestep COD income when you forgive debt the company owes you.

Example: avoiding COD income

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. 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 minus $50,000).

But you'd 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 no COD income.

Don't add extra stock

Don't take any additional corporate stock in exchange for forgiving the corporate debt. That could trigger taxable COD income for your corporation. If you own all the outstanding shares, not receiving any additional stock in the transaction leaves you in the same ownership position as before, so it makes no difference.

If you already own 100 percent of your company, receiving additional shares of stock in exchange is meaningless, since you already have complete control. So you can avoid COD income on the corporate level through your forgiveness.

Tip: This is a highly technical area of the tax law with potential repercussions on several levels. Consult with your tax pro concerning your personal situation.

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