Question

Sara is the sole owner of Yellow Corporation. Her basis in Yellow is $50,000. The value of her stock is $100,000. In addition, to compensate herself for services that she provides to Yellow, Sara pays herself an annual salary of $40,000. Because of recent downturn in business, she needs to put an additional $80,000 into her corporation to help meet short-term cash-flow needs (to pay for inventory costs, salaries, and administrative expenses). Should she do a capital contribution transfer of $80,000 or a loan? What is best for tax purposes? Explain your answer.

Help with clear explanation please!

Answer 1

Sara should take a loan of $80000 from the point of view of tax benefit because she will get tax deduction on interest paid on loan

Explanation.:

Given below are certain tax benefits under business loans:

1.Understanding interest

The business loan interest is a fee paid to the lenders for allowing the usage of the funds. This is the additional amount that the borrowers need to pay while borrowing the money.

2.Understanding tax deductible expenses

Tax deductible expenses are profitable for businesses to generate income. These expenses can be reduced from the gross profit or revenue to lower the taxable income. These can be subtracted from the revenues before computing tax liability. Before availing the business loan from a bank or financial institutions, it is necessary to know the terms and conditions such as interest rate, processing fees etc.

3. Deducting the business finance tax

YES, it’s true. Interest on business finance tax is deductible. Those companies that avail business finance is given benefits by tax authorities. Under this, the interest paid on borrowed amount is subtracted from the gross income. The promoters of the company maintain proper accounts of this payment which will serve as a proof in future if any need arises.
One important thing to consider is that the repayment amount is not tax deductible. This is because principal repayment means to pay back the money borrowed. The amount that you borrowed is not an income for business but an expense. This is the amount which is not earned which is why this amount is not tax deductible. Failure to repay the borrowed amount will lead to severe consequences. Therefore, every business must assess the situation first and then make a decision, whether or not they want to take a business loan.