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January 2013 » Distinguishing Debt from Equity
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Wei-Chih Chiang, DBA, and Ted D. Englebrecht, PhD
Because tax consequences of debt and equity financing are very different, it is crucial to decide whether a contribution to capital is a loan or an equity investment. If the contribution is recharacterized by the IRS, the impact on a taxpayer's tax liability could be substantial. For example, in Laidlaw Transportation Inc v. Comm'r (TC Memo 1998-232), the taxpayers' tax liability increased by more than $55 million after the IRS reclassified the debt as equity. Nevertheless, the question of how to distinguish debt from equity can be very controversial.
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