| Abstract: | This paper gives an in-depth look at the proposed regulations written by the Internal Revenue Service and authorized under Section 385 of the Internal Revenue Code. Included in the paper is a chart summarizing the various areas covered by these regulations, a glossary defining the many complex terms used, and a list of recommendations on how to avoid having debt reclassified as equity. The premise for this Code Section was to eliminate the use of debt financing which has equity-like features. This would be done by closely-held corporations for the various tax advantages of calling it debt. Some of the areas covered to preclude debt classification includes proportionately issued instruments when the corporation has excessive debt, the initial terms aren't at arms length, or the corporation fails to pay interest or principal when due. Hybrid instruments may be treated as stock if they are issued proportionately or if their equity features predominate. Other areas covered include unwritten cash loans, guaranteed loans, and preferred stock. |
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