Chapter Two -
Formation of a Corporation
Fundamental income tax elements:
1) Transferor: §351(a) - nonrecognition
treatment applicable to the asset transferor (if certain conditions are met);
otherwise: §1001 gain recognition.
2) Corporation: Tax-free treatment to
corporation issuing its shares. §1032.
3) Carryover tax bases to shareholder
(shares) and corporation (assets).
Section 351 Qualification
Requirements p.61
§351(a) - specific requirements:
a) one or more persons must transfer to
corp.;
b) they must transfer "property”;
c) transfer must be in exchange for
"stock" of the issuing corporation - not "securities”; and,
d) the transferor “group” must be in
"control" immediately after the exchange (but not be an “investment
company”).
What income tax objective for this
treatment?
Ancillary Income Tax Rules for §351
Transfers
Basis §358 - to shareholders
- basis of stock shall be same as the basis for transferred property.
Potential for double level of income taxation, i.e., to corporation &
shareholder.
§362 - transferred basis for assets shifted
into the corporation. Limit on built-in losses.
Holding period: §1223(1) -
transferor has a substituted holding period; §1223(2) - carryover holding
period to the corporation.
Limitation to Transferee when Built-in
Loss p.63
Potential for duplication of
economic loss.
IRC §362(e)(2) provides limit on
transferee’s “net built-in loss” when aggregate adjusted bases for properties
transferred exceeds total FMV.
Allocation proportionately of
built-in loss to various corporate assets.
Possible election to reduce specific
shareholder’s stock basis to fair market value & keep loss basis at corp.
level. IRC §362(e)(3)(C).
Incorporation Transaction
Problem p.64
Is §351(a) exchange treatment available?
a) Each party is a transferor of property
(including the transferor of money).
b) Each party has received X corporation
stock in the exchange.
c) The transferors (as a group) are in
“control” of X corporation.
d) No transferor has received
"boot" in this transaction.
Problem p.64, cont.
Treatment to A: A has no gain
realized.
$25,000 basis for stock received.
Need to clarify that money is “property” -
otherwise, only 75% (less than 80%) of the stock to transferors for §351
purposes.
Treatment to B: Realized gain of
$5,000.
Basis to B of stock received is $5,000.
No tacked holding period - since inventory.
Problem p.64, cont.
Treatment to C:
Realizes $5,000 loss on the land; but the
loss is not recognized on this transfer.
Substituted $25,0000 basis for stock under
§358(a).
Land is a capital asset – the holding
period is tacked - §1223(1).
Should C have sold the land to realize
& recognize the loss for C’s income tax purposes?
Problem p.64, cont.
Treatment to D:
$20,000 gain is realized on the
equipment transfer, but no gain recognition is required.
Depreciation recapture under §1245?
Provides that “such gain shall be recognized notwithstanding any other
provision.”
But, see §1245(b)(3) - an exception in the
§351 context. The depreciation recapture potential is preserved at the
corporate level.
Problem p.64, cont.
Treatment to E: Disposition of
an installment obligation occurs.
§453B(a) requires the recognition of the
gain upon the disposition of an installment obligation. The amount realized is
$20,000; tax basis in the note is $2,000 = $18,000 gain
But: Reg. §1.453-9(c)(2) specifies that no
gain recognition is required upon disposition of an installment
obligation in a §351 transfer.
Problem p.64, Part (b)
Tax consequences to the corporation:
1) §1032 - no gain on stock issuance.
2) Tacked holding period(s) for the
assets received - §1223(2) - but not for inventory.
3) Carryover tax basis for the various
assets received (§362): inventory - $5,000; land - 20,000 (not 25,000);
possible corporate election, §362(e)(2)(C)); equipment - 5,000; installment
note - 2,000.
Problem p.64, Part (c)
C transfers two properties:
Parcel 1: 10x FMV 15x
basis (loss)
Parcel 2: 10x FMV 8x
basis (gain) 20x 23x
(3x net loss)
§362(e)(2) requires a tax basis reduction
by 3x.
Netting of gains and losses is permitted.
Reduce tax basis of Parcel 1 from 15x to
12x.
Option to reduce C’s stock basis to 20x.
Problem p.64, Part (d)
Potential double taxation of inventory
gain:
$5,000 gain to B on the stock sale.
$5,000 gain to corporation on
inventory.
How prevent double gain (or double loss) if
so desired?
Step-up the shareholder’s basis if the corporation realizes the gain.
Step-down the shareholder's basis if the loss is recognized by the
corporation. Cf., partnership treatment.
“Control” Requirement
Defined p.65
§§351(a) & 368(c) - requires:
80% of voting power, and
80% of total value of all other stock.
If several transferors:
- an "integrated plan" is
necessary
- need not transfer all assets
simultaneously
- must, however, transfer with
"expedition consistent with orderly procedure."
Immediate Stock Disposition After Transfer
What if a disposition of the stock
occurs immediately after its acquisition?
Cannot be disposed of pursuant to a pre-existing
binding agreement.
Intermountain Lumber case - p.66
Issue: What tax basis of corporation's
assets (i.e., Intermountain) for purposes of tax depreciation - to the
acquirer; i.e., was the original transfer of the assets to the corporation
really a “sale”?
Rev. Rul. 2003-51 p.70
Holding Co. Structure
Transfer of assets to 1st
corporation for stock.
Then: (1) Transfer of stock of 1st
corp to 2nd corp & (2) transfer of assets to 2nd corp
by another transferor & (3) transfer of all assets to lower tier sub.
Prearranged binding agreement.
But: The nontaxable
disposition (not a “sale”) of 1st corp. stock after the 1st
§351 transaction does not violate the “control” requirement.
Transfers of “Property” and
Services p.71
Definition of "property”.
Stock received for "services" is not for property - §351(d).
What are “services”? Attorney; Promoter;
Goods with an installation/repair arrangement.
Effect on the 80% requirement of:
1) solely a service provider - not a
“transferor.”
2) both property (more than de minimis)
& services - included in control group, but some stock may be
gross income to the service provider/transferor.
Solely for “Stock” p.72
“Stock” means an equity investment in the
corporation and does not include:
1) stock rights or warrants (defined?)
2) securities (i.e., long term debt),
Previously “securities” permitted (how defined?), but eliminated from §351
eligibility; or
3) non-qualified preferred stock -
§351(g).
(how defined? See §351(g)(2)(A);
debt-like).
Problem 1(a) p.73
A as transferor is entitled to
§351 treatment:
50 of 60 shares. Exchanged basis of $10,000
in Newco stock. Tacked holding period under §1223(1) - assuming not inventory.
Corporation - §1032. No gain on issuance
of shares & cost basis to A. Reg. §1.1032-1(d).
B's transfer - not under
§351. B as the sole transferor. B owns only non-voting preferred (and
is not part of the 80% group).
Problem 1(b) p.73, cont.
Integrated plan
A & B transfer as part of an integrated
plan.
Both A & B each have Code §351
eligibility.
B can take only preferred stock. But, must
be qualified preferred - cf., Code §351(g).
Simultaneous exchanges are not critical if linkage
exists. Reg. §1.351-1(a)(1) specifies the transferors must proceed with an expedition
consistent with orderly procedure.
Problem 1(c) p.73,cont.
Post §351 Gift
1) Same as (b) - i.e., integrated
transaction; but March 5 transfer to daughter by A as a gift three days after
B's transfer. Transfer to D as a post-transfer transaction. Presumably not
a binding commitment by A to dispose of these shares.
2) January 5 transfer to D - 3 days after
A's transfer. Related? D is not a transferor for §351 purposes. B’s
transfer fails §351 eligibility.
Problem 1(d) p.73,cont.
Shares sold under a preexisting agreement.
If the transfer was an integral part of the
incorporation only 35 of the 50 shares (70%) were received under §351.
What about a step transaction, and
inclusion of E as part of the transferor group? No.
A and B to recognize gain on the exchange.
E would take a cost basis for E’s shares.
Problem 2(a) p.74
Incorporation Planning
Transferors (Java and Venturer) only own
350 of 500 (70%) shares & the control requirement (i.e., 80%) is not
satisfied.
§351(d) specifies that stock for services
is not considered as issued for property.
Java to recognize all realized gain. Issue
not relevant to Venturer since transferring cash.
Manager has compensation income - FMV of
the stock after the Manager’s receipt of shares?
Problem 2(b) p.74
Cash for Stock
Manager pays cash for stock. Therefore,
Manager is a member of the “control” group.
Java can then postpone gain recognition.
If a promissory note is issued - is this
"property"? Is the issuance of stock for a promissory note permitted
under local (corporate) law?
Consider the cash flow effect to Manager -
$80,000 salary less: (i) income tax, (ii) $30,000 note principal payment,
and (iii) note interest expense.
Problem 2(c) p.74
Limited Cash for Stock
Manager pays $1,000 for 150 shares.
Shares are worth much more and the shares
are really for performance of future services.
Manager is not a §351 “transferor”
after examining the substance of the transaction.
Therefore, Java is required to recognize all
realized gain on the Java transfer.
Manager: Ordinary income over the
$1,000 cost.
Problem 2(d) p.74
More than 10% Cash for Stock
Manager pays $20,000 cash (not $1,000).
Assuming $1,000 per share, the $20,000
transferred by the Manager will exceed 10% of value of the shares for
services. But, $130,000 compensation.
Manager is treated as a transferor - all
stock is counted for the transfer rule; the property transferred by
Manager will not be considered to be of "relatively small
value."
Java - no gain is to be recognized.
Problem 2(e) p.74
Delayed Stock Delivery
Manager receives only 20 shares without
restrictions and another 130 shares subject to restriction - a Code §83 issue
exists.
Are the 130 shares counted for §351
purposes?
If so, §351 qualification - if Manager’s
shares. Are the 130 shares treated as Treasury stock and not counted?
§83(a) - no income until the restrictions
lapse. §83(h). Function of the §83(b) election?
Problem 2(f) Possible Multi-Class Structure
Venturer receives nonvoting (?)
preferred shares. DRD eligibility. If nonqualified preferred stock,
should be received after the initial §351 transfers and in an unrelated
transaction. Use (convertible?) debt? - to enable an interest expense
deduction and repayment of debt without dividend consequences to Venturer.
Java - 51% to Java & the remaining
shares to manager? Lower the issue price and increase the incentive to
Manager.
Treatment of “Boot” Received in
Incorporation
§351(b); §358(a),
(b)(1); §362(a).
Gain realized is to be recognized, but only
to the extent of any “boot” received from corp.
Tax basis limits the total amount of
realized gain.
Allocation of the boot is
made (on a FMV basis) among the transferred assets.
Tax character of the gain is
determined by reference to the several asset(s) transferred.
Stock Basis Calculation when “Boot” is
Received
§358(a) - Tax basis for distributed
stock:
1) Tax basis of the asset
transferred to corp.
2) Less: FMV of the boot received
3) Plus: Gain amount recognized
4) Equals: Basis to the transferee
shareholder of the stock received.
Unrecognized gain remains in the
stock.
Basis for the boot: Fair market
value, since gain recognition occurring upon its receipt.
Rev. Rul. 68-55 p.77
Allocating boot gain
Determining the gain amounts, etc., when
receiving boot (§351(b)):
1) Asset-by-asset allocation approach.
2) Allocation of the boot consideration on
a relative fair market value of assets basis.
3) No loss recognition permitted; no
netting.
4) Divided holding period for shares
received.
5) Asset tax bases to corp. adjusted for
boot.
Stockholder’s Holding Period -
Corporation’s Tax Basis p.79
Shareholder’s holding period for
stock:
split holding period for each
share of stock, dependent upon each asset, including, if partially sourced
to inventory, no tacked holding period for that portion.
Transferee corporation’s basis for
various assets received: transferred basis, plus any boot/gain recognition
allocable to each particular item of property.
Timing Considerations for Boot Gain
Recognition
Installment gain treatment upon a boot
transfer (e.g., corporate debt received)?
1) When must the gain be recognized?
Later.
2) What impact to the shareholder's
stock basis under §358 for the stock received in the incorporation
transaction? Current increase.
3) Delayed impact under §362(a) to the corporation's
tax bases for these assets received? Cf., Crane case analysis re debt.
Tax Basis Allocation When
Boot as Installment Debt
Allocation of tax basis – page 82
1) First to the nonrecognition
property.
2) Any remaining (i.e., excess)
basis allocated to the boot to limit gain realized amount.
4) If installment note received (as
boot) allocation of any remaining basis is made under the installment method,
i.e., proportionately.
(Gain recognition timing affects
corp’s basis).
Problem:
Transferor A p.83
Transferor A: Equipment: $22,000
FMV;
15,000 basis; 7,000 realized gain
(all §1245).
Receives (i) common stock, (ii) preferred
stock (not “nonqualified”) & (iii) $2,000 cash boot (gain). A's tax basis
computation:
Adjusted basis 15,000
Less boot: 2,000
Plus: income (§1245): 2,000 =
15,000
continued
Transferor A, continued p.83
Allocation of the $15,000
shareholder basis between two types of stock (based on their relative
fair market values – 15 & 5):
3/4ths to common stock =
11,250
1/4th to preferred stock = 3,750
15,000
Corporation’s tax basis for A’s asset:
15,000 plus 2,000 gain recognized = 17,000
Transferor B p.83
Boot Allocation Issue
$13,000 gain on inventory - $20,000 fmv.
$3,000 accrued loss on land - $10,000 fmv.
B receives: $15,000 in stock & $15,000
cash.
Boot is to be allocated based on the
relative FMVs of the two transferred assets.
Boot allocated to inventory is 20/30 times
the $15,000 cash boot equals $10,000 gain.
Boot allocated to land is 10/30 times
$15,000 equals $5,000-but, no loss recognition. Cont.
Transferor B, p.83, cont.
B's basis in the stock: Code
§358(a)
7,000 inventory
basis
13,000 land basis
less: 15,000 boot received
plus: 10,000 gain
recognized
equals: 15,000 (20,000 less
5,000 cash). Stock holding period is proportionate for each share of
stock received. Cont.
Transferor B, p.83, cont.
Corporation's basis for assets: Code §362
1) Inventory 7,000 + 10,000 gain = 17,000
2) Land
13,000
Note: $30,000 aggregate basis not
exceeding the $30,000 fair market value and, therefore, no built-in loss/§
362(e)(2) applicability.
Transferor C p.83
Two types of boot received
Land basis is $20,000 and FMV is $50,000.
$30,000 realized gain on the transfer of
land.
Stock is received & two types of
boot are received: (1) 5x cash & (2) two year 35x note.
All $30,000 gain is to
be recognized (not $40,000) - see §351(b)(1). All gain is LTCG.
Basis is allocated first to the
non-recognition property. continued
Transferor C p.83,cont.
When reporting on the installment method:
Basis 1st to the nonrecognition property
(i.e., the X stock - $10,000).
Remaining $10,000 is excess basis to
the boot.
Gross profit ratio 30,000 (10,000
for basis)
40,000
equals 3/4
3/4 of 5,000 cash equals 3,750 current
gain.
3/4 of 35,000 = 26,250 - recognized in two
years.
Transferor C p.83,cont.
Stock basis
C’s stock basis computation:
Land basis: 20,000
Less: boot received: 40,000
Plus: gain recognized: 30,000
Equals: 10,000
Treated as electing out of §453 installment
treatment for shareholder tax basis purposes.
Problem (b) p.83
§453(i)
C transfers depreciable equipment (instead
of land):
Same basis: 20,000
Same FMV: 50,000
Original cost: 50,000
Entire $30,000 would be §1245 gain
to be recaptured into income immediately.
Tax basis to the shareholder &
corporation?
Assumption of Liabilities
§357 p.83
Remember the Crane case: debt relief
constitutes an “amount realized.”
§357(a) - the assumption of liability (or
the taking of property subject to a liability) will:
(1) not constitute “boot”
and
(2) not prevent §351
treatment.
How take this into account? adjust tax
basis, as required under §358(d). Reduce the tax basis by treating the
debt assumption as money received.
Section 357(b) Exception
if a “Tax Avoidance Purpose”
§357(b). Tax avoidance purpose
limitation.
A liability assumption is treated entirely
as boot if the taxpayer's principal purpose in transferring some
liability was the avoidance of federal income tax or was not for a bona fide
purpose.
Bona fides measured at the corporate level.
Purpose: to avoid a pre-§351 cash
“bailout” (i.e. borrowing against property immediately before an incorporation
transfer).
Section 357(c) Exception if
Liabilities Exceed Basis
§357(c). Liabilities in excess of tax
basis of the transferred property produce a gain amount.
Total of the liabilities
in excess of the total of asset bases triggers applicability of this
provision.
The excess is treated as gain from the sale
or exchange of property.
Exception for those
liabilities deductible when paid. §357(c)(3). This enables avoiding a gain
problem for cash basis taxpayers (i.e. accounts payable).
The Excess Liabilities
Problem p.87
How solve this liabilities exceeding basis
problem – to avoid gain recognition at incorporation time?
- Contribute cash to equalize
- Contribute high-basis debt-free property
- Contribute a promissory note in an
amount at least equal to the “negative basis”
- Remain personally liable on the debt
property?
Peracchi case p.88
Promissory Note & Tax Basis?
Taxpayer contributes real estate to his
corporation. Real estate subject to debt in excess of its tax basis.
The taxpayer also contributes his
promissory note - face value in excess of §357(c) amount.
Held: Note has a tax basis equivalent to
face amount - eliminating the §357(c) problem.
Note is either to be paid by the taxpayer
or collected in the corporation’s bankruptcy estate.
Note is not a “sham” (p. 96). See IRS
stipulation re business purpose existing.
Alternative §357(c) Planning –
Retain Liability?
P. 99. Retention by the shareholder of the
personal liability for the liability attached to the transferred asset. Does
this enable the avoidance of the §357(c) effects? No avoidance. (Tax Court).
What effect of entering into an agreement
that the shareholder (not the corporation) will satisfy the debt (e.g., guarantee
agreement)? Court position: guarantees are not the same as debt
(including shareholder’s promissory note).
Seggerman Farms
Footnote 8, p.100
Taxpayers contributed assets subject
to liabilities exceeding tax basis.
But, taxpayers remained liable as guarantors
of these liabilities.
Court of Appeals ruled §357(c) gain is
to be recognized on the transfer.
Personal guarantee of the
shareholders is not the equivalent of primary liability.
Correct result?
What are the terms in a guarantee
agreement?
Problem 1(a) - Liabilities not
Exceeding Basis p.102
Basis FMV
Inv. 20,000 10,000
Land 20,000 40,000
40,000 50,000
Land (recourse) debt is 30,000 & X
takes land subject to this debt.
Stock is issued for 20,000 (50 fmv less 30
debt).
No gain is to be recognized.
Stock basis: 40,000 less 30,000 debt =
10,000 excess.
Problem 1(b) – Liabilities Exceeding
Basis p.102
Basis
FMV
Inv. 20,000 10,000
Land 5,000 40,000
25,000 50,000
Debt assumed is 30,000 (30 exceeds 25
basis).
Gain to be recognized is 5,000; Stock =
20x FMV.
Stock tax basis: 25,000 less 30,000, plus
5,000 (gain to be recognized) equals 0 basis.
Problem 1(c) p.102
Tax Character of 5,000 Gain
What tax character of A's recognized
gain?
Reg. §1.357-2(b). Allocate the §357(c)
gain of $5,000 between the transferred assets based on the relative fair
market values (without consideration of the debt or tax basis).
Inventory 10,000/50,000 20%
= 1,000
Land 40,000/50,000 80%
= 4,000
5,000
Problem 1(d) p.102
Tax Basis Allocation
1) If allocating the entire gain to the
land (since the land is the only appreciated asset):
inventory 20,000 basis
land 5,000 -
plus 5,000 gain = 10k Gain recognized and total basis for land is $10,000.
2) If allocation is on the basis of asset FMV:
inventory 21,000 (20,000
plus 1,000)
land 9,000
(5,000 plus 4,000)
Problem 1(e) p.102
Avoiding Gain Recognition
Avoiding gain recognition:
1) Transfer into Corp: (a) $5,000 cash, or
(b) any other asset with an adjusted basis of at least $5,000.
2) Remain personally liable on at least
$5,000 of the mortgage. ??
3) Transfer a personal promissory note for
$5,000 to the corporation (e.g., Peracchi).
Problem 2(a) p.102
Liabilities assumed
Building is transferred - basis $100,000;
fair market value - $400,000; subject to $80,000 first mortgage; borrowed
$10,000 on the building two weeks before incorporation of Y; and, issuance by Y
of $310,000 in stock (400 less 80 and 10).
Code §357(b) is applicable -
assuming no bona fide business purpose for the borrowing for personal reasons
immediately prior to incorporation transfer. Bailout amount? cont
Problem 2(a), cont. p.102
B’s basis in the Y stock would be
determined as follows:
Transferred tax basis of the
building: $100,000
Less: $90,000 liabilities
assumed
Plus: $90,000 gain
recognized
Equals: $100,000 basis
Problem 2(b) p.102
Only Cash Boot
Cash - bank to Y Corp, then to
shareholder.
B will only recognize the $10,000 cash
boot.
B’s basis in the Y Corp stock would be:
$100,000 transferred basis of
building
Less: $80,000
liabilities assumed
Less: $10,000 cash
received
Plus: $10,000 gain
recognized
Equals: $20,000 basis
for stock
Incorporation of a Going Business p.103
Transferred assets might include:
Land & Building (depreciated)
Machinery & equipment
Goodwill
Accounts receivable and inventory
Previously deducted supplies
Assumed liabilities might include long term
debt, accounts payable, contingent liabilities.
Hempt Brothers p.103
Accounts Receivable
Facts: $662,000 in zero basis
accounts receivable transferred to a new corporation in exchange for stock.
1) IRS claims partnership's zero
basis in the receivable carried over to corporation - corp. realizing income
upon collection.
2) Corporation contended
receivables were not “property” & transfer to corporation was an
"assignment of income”.
Rev. Rul. 95-74 p.107
Environmental liabilities
§357 effect of potential future
liabilities.
Parent drops assets into sub – with
possible environmental liabilities (CERCLA).
These liabilities are assumed by
subsidiary.
1) These potential liabilities are not
“liabilities” for §357(c)(1) (and §358(d)).
2) Liabilities assumed by the sub are
deductible (or to be capitalized) when paid (by the cash basis taxpayer).
Possible Code §351 Abuse
Situations P.110
1) Applicability of the "assignment of
income" doctrine.
2) Code §482 is used to appropriately
allocate income among taxpayers (e.g., cannot accelerate deductions and deflect
related income to corporation).
3) “Tax benefit rule” - deduction of the
cost of property prior to its transfer to Corp. Note the Hillsboro case (p.
112).
Problem (a) p.113
Incorporation Transfers
Possible tax consequences:
Is gain to be recognized?
Do the assumed liabilities exceed tax
basis?
No, consider §357(c)(3).
Liability assumed of $30,000 (not 100x) is
less than the $60,000 tax basis.
Tax basis for the shares received:
$60,000 less 30,000 = $30,000
Problem (b) p.113
Cash basis taxpayers
Collection of zero basis accounts
receivable:
1) Architect is not taxed because the A/Rs
are "property" under §351 and can be assigned to the
corporation without income recognition. The corporation has income when the
A/Rs are collected (i.e., a cash basis taxpayer).
2) The “assignment of income” doctrine does
not apply if a valid business purpose exists for the transfer of
the accounts receivable.
Problem (c) p.113
Accounts payable assumed
Deduction by the corporation of accounts
payable which were assumed?
Yes, deduction to the transferee of
the accounts payable is permitted under Code §162 when accounts payable are
paid - unless evidence exists of tax avoidance or the distortion of income.
Problem (d) p.113
Partial Transfer
Payment of the accounts payable but
transfer of the accounts receivable to the corporation.
Is the “assignment of income” doctrine
applicable in this situation?
Evidence of tax avoidance or the distortion
of income existent here? Probably.
What relevance of §446(b) (“clear
reflection of income”)?
Problem (e) p.113
Accrual Basis Transferor
Payment of the accounts payable by
Transferor but transfer of the accounts receivable to Corporation.
But, Architect as an accrual basis
taxpayer.
Receivables would have been included in GI.
Payables would have been deducted & an
assumed liability to Corp.
Stock basis: 60 plus 60 = 120 less 100
debt = 20 basis (and no § 357(c) gain).
Problem (f) p.113
Accounting Method
Limitations of the choice of accounting
method? See §448.
Design probably a “qualified personal
service corporation” - see §448(b)(2) & (d)(2) – and, the accrual method
is not required.
Is the calendar year required? Yes, see
§441(i)(2).
Contingent Liability Tax Shelters &
§358(h) p.113
Black & Decker Corp v. U.S.
Motion for Summary Judgment
Is tax basis in stock of sub to be reduced
by the contingent liabilities assumed by the sub?
Held: no; deduction to the
subsidiary & capital loss to parent corp. when selling stock? But, see
(subsequent) §358(h) basis limitation to the FMV of the stock received.
Intentional Avoidance of Code
§351 p.121
Code §351 is not an elective
provision.
Objectives when seeking to avoid §351:
1) Enable a loss deduction (ordinary?).
2) Step up the tax basis for
depreciation.
3) Freeze capital gain potential.
Techniques for avoiding Code §351:
1) Immediately breaking 80% control.
2) Sale of an asset to the
corporation (with §453 installment sale treatment).
Contributions to Capital -
p.123
Code §§118(a) & 362(a)(2), (c).
1) No receipt of stock for property
sent to corp.
2) No gain is to be recognized; but, an increase
to shareholder of tax basis for stock by the cash and adjusted basis of
property transferred.
3) This contribution is excludable from the
gross income of the transferee corporation.
4) Transferred tax basis to the corporation
for the assets received.
Commissioner v. Fink, p.124
Loss Deductibility?
Controlling shareholder surrenders some
shares to corporation, but retains control. (72% to 68%).
What (if any) deductibility (ordinary
loss?) of the tax basis for the surrendered shares?
Held: voluntary surrender of some shares
& constitutes a contribution to the capital of the corporation.
Objective: to enhance the corp.
No immediately deductible (ordinary) loss
actually sustained during taxable year. Reallocate tax basis.
Organizational Expenses -
Is a Deduction Available?
Code §195, §212(3) & §248
§248 – $5,000 deduction & 180 months
amortization for organizational expenses.
§248(b) - defining “organizational
expenses”:
legal fees for drafting the articles of
incorporation, but not the costs for issuing or selling the stock.
§195 – $5,000 start-up expenditures
deductible, with 180 month amortization for remainder,
Problems p.130
Appraisal Fees
a) $3,000 fees paid for appraisals of A's
proprietorship.
A's personal cost and not an expense of the
incorporation. An expense of acquiring the stock and added to the tax basis
for the stock.
b) Fee paid by the corporation. Treated as
a liability of Shareholder A which is assumed by the corporation and is
subject to §357 liability treatment.
Problem c p.131
Document Preparation
i) Drafting the articles of incorporation
- §248 election enables an expense
deduction & amortization. Reg. §1.248-1(b)(2).
ii) Deeds, etc. - constitute costs of the
specific assets & to be added to the tax basis of these assets.
iii) Application to issue stock - not
considered an organizational expense; also, not otherwise deductible or
amortizable. Reg. §1.248-1(b)(3)(i). continued
Problem c p.131
iv) §212(3) deduction treatment is not
available since not applicable to corporations.
Not a §162(a) expense, but should be
includible in the organizational expenses under Code §248 and amortizable.
v) Buy-sell agreement - organizational
expense under Code §248?? and, therefore, amortizable?