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What are the main differences between corporate debt and
equity? Why do some firms try to issue equity in the guise
of debt?
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Answer Posted / a.b.
Firms try to issue equity under the guise of debt because
the firm can take a deduction on all interest paid
throughout the year. Thus, the firm can enjoy pass-through
taxation, theoretically, on the payment of the interest
because those dollars are tax-free. This reduces the
overall taxable income of the firm, which reduces the tax
burden, which may even result in more money to distribute as
dividends to those equity holders. It's a win-win situation
for all, except the IRS. Thus, the IRS/Congress created 385
of the Internal Revenue Code which allows the IRS to
evaluate corporate debt to determine if it is essentially
equity under the guise as debt and treat it as such.
The above answers regarding the nature of debt and equity
are correct for the most part, but do not go far enough to
answer the question asked.
| Is This Answer Correct ? | 3 Yes | 1 No |
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