When Keith created a new corporation as the sole shareholder, he was advised by his accountant
to treat 50 percent of the amount invested as a loan and 50 percent as a purchase of stock. What
are the advantages and disadvantages of this structure as compared with treating the entire
investment as a purchase of stock?
Solution
The corporation will be able to pay interest on the debt and deduct the interest
from its gross income. If the corporation pays dividends on the stock, the
dividends are not deductible by the corporation. Whether the payment is interest or
dividends, the shareholder recognizes income for the amount received; however,
dividend income is taxed at a lower rate. Another consideration is that the
corporation can repay debt with no tax consequences to the shareholders. If the
corporation retires a shareholder