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Shared Pockets Entail shared Tax Trouble

Updated on January 16, 2013

Related Party Loans

Related party loans must carry interest in one form or the other which should be visibly fair otherwise the IRS officials may reopen the case and recalculate the interest to be paid on the principal amount.

Usually there are in business related party transfers or the veterinary practices of transferring money or advancing money and this could be in the form of paying for the other party's debt obligations.

Often, the payments within the fold of incorporated practice are tax-free but there may be certain other types of tax liabilities. Usually, it happens that the tax advisers of the company concerned ignore the routine transfer of money between the shareholders and the company under the veterinary practice and it is so because the ever-vigilant officials of the IRS (Internal Revenue Service) hardly go after this loophole.

IRS Tax Trouble

IRS Pursues Cross Loans

Usually, the officials of the IRS ask the incorporated companies to distribute the operative profits of the company concerned as dividends rather than to pay for the compensations and this was prior to the enactment of the laws pertaining to the lower and temporary rates applicable on the dividend payouts.

Any extra type of compensation which is paid and comes under the vigilant eyes of the IRS officials would mean that the principal party/shareholder was trying to avoid the double taxation on the dividend income - for the first time when the payment is made by the company and for the second time when the receipt of the dividend is there at the end of the shareholder. But now the times have taken a change.

Now the officials of the IRS go in for the finding out of related party transactions, particularly the so called "cross loans" and others "below-market" loans that constitute a transaction between a company incorporated and any of its many shareholders. And it is as my own personal pocket and my business books are two different identities.

Often when a big shareholder having controlling rights in the company opts for advancing money to the company concerned, then it is assumed to be the contribution to the capital on the part of the shareholder concerned and as such there is no question of any tax liabilities. On the other hand, many other transfers between a shareholder and a company should involve the payment of due interest on the transferred amount.

The interest payments made by the borrower company and deducted from the Profit & Loss A/c would constitute as an income of the lender shareholder. A lower rates of interest or the negligible rates of interest on the amount would involve naturally a lower tax liability for one party i.e. the party in receipt of the interest payments.

Such a transfer of money from the shareholders to their company, usually called a veterinary practice in business terms, does not require any other tax deduction as the interest payments are ignored or are reported at a very lower rates of interest. If there is any transaction of money involved within the concerned parties, i.e. the family members, between a partner and his/her partnership firm, a veterinarian and his/her incorporated company is classified as a related-party transaction unless and until qualified otherwise in some other category.

The tax officials concerned with the IRS have the powers to reopen the related transaction and go through the same thoroughly. This would result in the payment of interest from the lender to the borrower at a rate of interest deemed to be fair and fit for the transaction by the IRS officials. These types of hits of retroactive nature could become a cause for the substantial tax bill on the part of the lender party.


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