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Vanderbilt Law Review

First Page

1423

Abstract

By borrowing money and purchasing preferred stocks with an average yield greater than 58% of the interest rate on the debt, a corporation at the maximum marginal tax rate can reduce its federal income tax liability. In evaluating the potential benefit of this practice, the corporation must consider transactions costs and its ability either to tie the debt to the equities or to have a sufficiently distant maturity on the debt to weather interest rate cycles that depress preferred stock prices. A small to medium-sized corporation probably is in a better position to obtain appropriate debt and to purchase enough equities, without depressing yields, to make the use of fully leveraged equity investments have a significant impact on its tax liability. A corporation would also have to assess the chances that the dividends would cause personal holding company tax liability in periods of low operating earnings. In securing the loans, the corporation would have to avert the danger that interest deductions might be disallowed under tax rules pertaining to related parties, capital structure, and debt-financed corporate acquisitions. An analysis of the past application of the interest deduction disallowance provision relating to the holding of tax-exempt securities indicates that the government would have difficulty in creating and applying to corporations an interest disallowance provision when high-yield equities, rather than tax-exempts, are related to the d

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