Sunday, March 11, 2012

Debt-Equity Ration and Thin Capitalization

What is considered Thin Capitalization?

If a corporation has excessive liabilities in comparison to the capital contributions in its shareholder's equity, the lenders giving loans have a significant risk.  In tax and accounting terms, this means that the corporation is regarded as being thinly capitalized.

The lack of a decent amount of equity increases the riskiness of the debt  investment that lenders made. This factor could be a factor to the IRS when it decides to re-classify the debt as equity. It is important that corporations have a healthy mix of both equity and debt in order to carry on their normal business operations and avoid an IRS audit that might re-classify facially decent debt as equity.

No comments:

Popular Accounting Problems

The information on this site is for informational purposes only and should not be used as a substitute for the professional advice of an accountant, tax advisor, attorney, or other professional.