Thin Capitalization (Thin Corporation)

A Corporation whose capital is supplied primarily by loans from shareholders rather than stock investment. The main tax advantage attempted is that the distributions of interest on the debts may be deducted by the corporation as Interest, whereas distributions on stock are nondeductible Dividends. If the debt-to-stock ratio becomes excessive, the IRS may contend that the capital structure is unrealistic and the debt is not Bona Fide. The acceptable debt-to-stock ratio varies according to industry norms. If the corporation's debt is recast as stock, the corporation loses its deductible interest expense.