Running head: CAPITAL STRUCTURE 1

Capital Structure

Dollie Moore

South University Online

CAPITAL STRUCTURE 2

Capital Structure

Juan would not be able to count the gain or loss because his children are a related party.

26 U.S. 267 (c) (4) states: The family of an individual shall include only his brothers and

sisters (whether by the whole or half-blood), spouse, ancestors, and lineal descendants (n.d.).

Lineal Descendant: A person who is in direct line to an ancestor, such as child,

grandchild, great-grandchild and on forever. A lineal descendant is distinguished from a

"collateral" descendant which would be from the line of a brother, sister, aunt or uncle (Burtons

Legal Thesaurus, 2007). 351 tells us that there will not be a recognition of gain or loss if

property is transferred to a corporation in exchange for stock only by one or more persons.

Section 351(a) provides that no gain or loss shall be recognized if property is transferred to a

corporation by one or more persons solely in exchange for stock in such corporation and

immediately after the exchange such person or persons are in control (as defined in 368(c)) of

the corporation (Leong, n.d., p. 1). In this situation, there will be no recognition of gain or loss.

The advantages and disadvantages of utilizing debt rather than equity is debt interest is

deductible, but dividend payments are not. If loan repayments do not exceed basis, they are not

taxable to the investors. Debt does not dilute the owners interest in the company, and raising

capital is easier. Debt must be repaid, equity does not. During difficult financial periods, high

interest cost may increase insolvency risk. The bigger the companys debt-to-equity ratio is, the

riskier the company is to investors. Dividend income on equity holdings is taxed to individual

investors at low capital gains rates, while interest income on debt is taxed at higher ordinary

income rates (Hoffman, 2017, p. 18-19).

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The loan is on open account: An open account advance is more easily characterized as a

contribution to capital than a loan evidenced by a properly written note (Hoffman, 2017, p. 18-

20).

The loan is payable on demand: A lender unrelated to the corporation will usually be unwilling

to commit funds to the corporation without a definite due date (Hoffman, 2017, p. 18-20).

The corporation does not make timely repayments: A lenders failure to insist upon timely

repayment or satisfactory renegotiation indicates that the return sought does not depend upon

interest income and the repayment of principal (Hoffman, 2017, p. 18-20).

Payments are contingent on earnings: A lender ordinarily will not advance funds that are likely

to be repaid only if the venture is successful (Hoffman, 2017, p. 18-20).

The loans are in the same proportion as the shareholdings, and the corporation uses the funds to

purchase a new building: When debt and equity obligations are held in the same proportion,

shareholders are, apart from tax considerations, indifferent as to whether corporate distributions

are in the form of interest or dividends (Hoffman, 2017, p. 18-20).

Funds used to finance initial operations or to acquire capital assets the corporation needs are

generally obtained through equity investments (Hoffman, 2017, p. 18-20).

The corporation's debt-equity ratio is 5:1: Indicates that the corporation lacks reserves to pay

interest and principal on debt when corporate income is insufficient to meet current needs.34 In

determining a corporations debt-equity ratio, courts look at the relation of the debt both to the

book value of the corporations assets and to their actual fair market value (Hoffman, 2017, pp.

18-20-18-21).
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References

Burtons Legal Thesaurus, 4E. (2007). Lineal Descendant. Retrieved from:

http://legal-dictionary.thefreedictionary.com/lineal+descendant

Cornell University Law School (n.d.). 26 U.S. Code 267. Retrieved from:

https://www.law.cornell.edu/uscode/text/26/267

Hoffman, W. H. (2017). South-Western Federal Taxation 2017: Comprehensive, 40th Edition

[VitalSource Bookshelf version]. Retrieved from:

https://bookshelf.vitalsource.com/books/9781337342070

Leong L. K. (n.d.) Section 351Transfer to Corporation Controlled by Transferor. Retrieved

from: https://www.irs.gov/pub/irs-drop/rr-03-51.pdf