This loophole is simple to setup and follow. All your client has to do is to lend their corporation some money. This works as long as they are a shareholder in their company but don’t own more than 50% of the stocks. After your client lends the company the money, they forgive them the "principal", meaning the corporation doesn’t have to pay them back. This is what is commonly referred to as a tax shelter.
Under this tax shelter, your client has contributed money to their company tax-free and if they owned stocks in the company, the forgiven principal increases the cost basis of the stocks that they own. This means that because the purchase price (cost-basis) of their stocks went up, the capital gains tax that they would have paid decreases. According to the books, your client makes less profit hence they pay fewer taxes.
The loophole for the company is the one that IRS has been fighting for years without success. The owner who lends money to his company forgives the principal plus the interest on it. This means that the corporation doesn’t have to pay the interest but they can report the amount on their tax returns to receive a deduction for it. In turn, this means a huge bite out of your client’s corporate taxes and additional money in the company.
