Help on the federal income tax.?

Question

Explain how the federal income tax structure impacts a business decision to finance with use of debt vs. equity.

Answer 1

You're allowed to deduct interest on debt from your taxable income. You're not allowed to deduct dividends paid on equity from your taxable income.

However, there are special thin-cap rules where the IRS can recharacterize certain owner-financed debt as equity if there is too high of debt compared to equity. You'll be disallowed a deduction for interest, and the payments could be potentially reclassified as dividends (if you have earnings and profits).

Answer 2

I'm sure they probably mean debt instruments and equity instruments such as with stock and things like that. That is the only think that makes any sense as to how it affects dividends etc. pretty sure of that but we're not supposed to be doing people's homework. Financial Accounting Standards Board, AICPA and others are good starting points. Lot of good stuff there. Now being in business it doesn't affect my decisions to hire people etc. Economics does. but really though, the need to get the job done in the most efficient manner possible mostly does. Income tax is just like death. We can't do much about both. Good luck Wayne

Answer 3

The income tax system for businesses favors borrowing over saving. If you pay cash, you usually cannot deduct the whole cost of capital goods in the year you pay for it. Instead, you have to depreciate over a number of years depending on the capital goods.

When you finance such a purchase, you can also deduct the interest paid.