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Bobby loaned $500,000 to a corporation of which he is the sole shareholder. The corporation signed...

Bobby loaned $500,000 to a corporation of which he is the sole shareholder. The corporation signed a valid note for the loan and the interest rate is 10% and is reasonable. The corporation has made principal and interest payments to Bob each year according to the terms of the note. The IRS is threatening to recharacterize the loan as a contribution to capital. Discuss the tax consequences to both Bobby and the corporation if:

(1) the payments are correctly characterized as principal and interest

(2) the IRS is successful in recharacterizing the loan as capital.

Business   Accounting   
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Answer #1

1. if the payment is correctly characterized as principal and interest, then the corporation will not include principal in its gross income but the interest will be deductiable for the corporation and taxable in the hands of Bobby. the principal repayment is not taxable to Bobby as it the money after tax.

2. in case IRS is successful in recharacterizing the loan as capital, there will be no tax consequences to bobby or the corporation as the capital contribution is tax free and bobby can withdraw his contribution.

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