Donald R. Ames


Section 385 of the Internal Revenue Code authorized the Treasury to prescribe regulations to help both courts and taxpayers determine whether an interest in a corporation qualified as debt or equity for federal income tax purposes. On December 29, 1980, Treasury Decision 7747 was issued stating the final regulations for determining whether certain interests in a corporation should be treated as stock or indebtedness. The regulations are intended to provide certainty through objective tests for an area heretofore plagued by confusion. The new rules will generally apply to certain interests in small, closely held corporations created after April 30, 1980. The regulations, however, are a departure from the goals stated by Congress in 1969. The regulations will serve to eliminate controversy in numerous cases, but they will also cause problems for many corporations not publicly traded or widely held. This Note will deal with some of the binding and conclusive determinations contained in the regulations. Section II will present some of the reasons for financing a corporation with debt. Section III will discuss tests to be used in determining whether a debt instrument is actually equity. Debt instruments convertible into equity will be analyzed in section IV and loans made to a corporation guaranteed by its shareholders will be discussed in section V.