Interest expense: new limits on deductions for corporate stock purchases.

The IRS ruled individuals who purchase 100% of a regular or C corporation's stock must treat the interest expense on the stock acquisition loan as investment interest (revenue ruling 93-68, IRB no. 1993-33). This means, under the limits of tax code section 163(d), individuals may deduct only the loan interest to the extent of offsetting investment income that is generated by the stock.

The ruling dismissed a taxpayer's assertion that such a stock purchase was motivated by a desire to protect employment with the corporation. The motive for purchasing the stock, the IRS said, did not overcome the investment nature of the stock purchase.

Observation: Investment interest expense that exceeds current investment income and is therefore not deductible has an unlimited carryforward for use against future investment income.

However, as a result of the Omnibus Budget Reconciliation Act of 1993, stock and security gains no longer may be treated as investment income unless taxpayers elect to forgo the favorable 28% capital gain rate.

Strategies to improve the tax result for purchasing stockholders include electing S status, which allows the interest expense to be claimed on schedule E in the same location as the S corporation schedule K-1 pass-through income or loss (see IRS notice 89-35).

Also, a "bootstrap" stock redemption (in which individuals buy only a small portion of the stock and the corporation redeems the remainder of the seller's stock) allows a portion of the interest expense to be paid within the corporation--although this results in a lower stock basis for the purchasing individual.