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Seek divine forgiveness on company debt to avoid taxes

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in Small Business Tax,Small Business Tax Deduction Strategies

Is your closely held company struggling in these tough economic times? If it is, there’s some consolation: You’re not alone. Nevertheless, you may need to take some drastic measures, especially if the company already owes you money for a prior debt.

First, forgive the debt. Next, treat it as a contribution to your corporation. As long as you handle things correctly, neither you nor the corporation will have to pay any tax on the transaction.

Normally, forgiving a debt results in “cancellation-of-debt” (COD) income that is taxable to the corporation. But a loophole in the tax law allows a company to effectively avoid COD income when it forgives a debt owed to the owner (you).

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 back stock if you own all of the outstanding shares.  Because you probably own 100% of the company, you’re in the same stock ownership position as you were before the debt forgiveness.

Finally, note that the new economic stimulus law provides some relief for certain firms repurchasing debt in 2009 and 2010 at a discount. The corporation can elect to defer tax to 2014 and spread it out over five years.

This is a highly technical area of the tax law. Consult with your tax pro.

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