Corporate Formations, Debt vs. Equity, and Income Tax

Flashcards covering key vocabulary and concepts from a lecture on corporate formations, debt vs. equity, and income tax.

Boot

Cash or property other than stock received in an otherwise tax-free corporate formation. Gain is recognized to the extent of boot received.

Section 351

Deals with tax-free transfers to a corporation when certain conditions are met (e.g., control, etc.).

Debt Financing

Financing a business with borrowed money (e.g., from banks, vendors, bonds). Interest paid on debt is usually tax-deductible.

Equity Financing

Financing a business by selling ownership shares in the company.

Accounts Payable

Money owed to vendors for goods or services received. Typically does not accrue interest.

Accrued Expenses

Expenses that have been incurred but not yet paid. These often do not accrue interest (e.g. employee wages).

Debt to Equity Ratio

A metric used to assess a company's financial leverage, calculated by dividing total debt by total equity. Indicates risk level.

Leverage

Using debt to finance assets, which magnifies returns (and losses) to equity holders.

Return on Equity (ROE)

A measure of financial performance calculated by dividing net income by total equity. Indicates how efficiently a company generates profits from shareholders' investments.

Hybrid Instruments

Financial instruments that have characteristics of both debt and equity.

Substance Over Form

A legal doctrine where courts look at the real economic nature of a transaction, rather than its stated or paper form.

Section 385

Provides factors to determine whether a debtor-creditor relationship or a shareholder-corporation relationship exists, especially for hybrid instruments.

Section 1244 Stock

Allows for an ordinary loss deduction (instead of a capital loss) on the sale of stock in a qualifying small business corporation.

Ordinary Loss

A loss that can offset any type of income without the limitations imposed on capital losses.

Capital Loss

A loss from the sale of a capital asset; deduction is limited to capital gains plus up to $3,000 of other income.

Section 1202 Stock

Qualified small business stock that, when sold after being held for at least five years, may qualify for 100% exclusion from capital gains tax.

Adjustments to Gross Income

Deductions taken to arrive at Adjusted Gross Income (AGI); can include items like certain business expenses, student loan interest, and IRA contributions.

Personal Service Corporation

A corporation where the principal activity is the performance of personal services substantially performed by employee-owners.

Gross Profit

Revenue minus cost of goods sold.

Section 61

Defines gross income as all income from whatever source derived.

Section 162

Authorizes deductions for all ordinary and necessary business expenses.

Schedule M-1

A form used to reconcile net income per books with taxable income on the tax return.

Schedule M-2

Analyzes changes in retained earnings from the beginning to the end of the year.

Temporary Difference

A difference between the book and tax basis of an asset or liability that will reverse in a future year.

Permanent Difference

A difference between book and taxable income that will never reverse (e.g., tax-exempt interest).