When a corporation is thinly capitalized, the IRS is more likely to reclassify a portion of the corporation's debt as equity.

Question

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Thin capitalization means that a corporation has a high level of debt and a low level of equity. When a corporation is thinly capitalized, the IRS may reclassify some of the debt as equity because it appears that the corporation is not able to support the debt with sufficient capital. This can result in changes to the tax treatment of the corporation's income and expenses.

When a Corporation Is Thinly Capitalized, the IRS Is More