Is there any way to structure a convertible note so that investors don't get interest income (1099-INT) when the note converts to Series A preferred? (Convertible notes convert principal and accrued interest to the next "qualified equity financing.")
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Assume investor invests $50,000 in Convertible Note at 5% interest, which converts to Series A in a year. He is issued $52,500 worth of Series A. Can this transaction be characterized so he holds those shares with a $50k basis and doesn't recognize the $2500 as interest income for tax purposes? Yes, in that case the basis would be $52,500, but the investor would rather not pay tax on something that did not generate cash and which may fail.
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Answer:
Yes there are ways to do this, but you are getting into a highly unique structure that goes way beyond what could be explained in a Quora post. You should also know that the methodology is not always that popular because it also prohibits the company that issues the bonds from taking a tax deduction for any accrued interest on the bonds. If you really want to know more start by researching Bethlehem Steel vs United States, Columbia Gas vs United States, revenue ruling 68-170 and Treasury Reg 45. (that last one is a good one as it is from 1920)
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