CH 19: Corporate Formation and Liquidations

IRS Section 351 is:

transfers of property to a corp in exchange for stock and control

What was the example Brad gave for capital contributions?

FujiFilm in College Station

government incentives to bring a business or group to an area

capital contributions

Why do governments use capital contributions? 

Bring jobs and intellectual capital to an area 

What is the death of a corporation called?

liquidation

What are the ways/times a corporation is formed

Creating a new company
Converting an existing business
M&A

Exchanges in property are generally taxable unless

they meet the exception in Code 351

What needs to occur for a transfer of property to a corporation to be considered an exception under section 351

Transfer of property to corp 
In exchange for stock
Substantive Change

Section 351 postpones recognition of gain or loss from transfers of property to a corp until ___ in the taxpayers investment occurs (Creates tax neutrality)

substantive change

When does a substantive change occur?

Sell the stock
Partial Liquidation (BOOT)

If boot is received in a section 351 trade, the recognized gain is:

the lessor of realized gain and boot received

Realized Gain =

FMV property received
+ Boot received
+ Liab taken on by corp
- Tax basis property transferred
- FMV boot paid
- Liab taken on by you

Section 351 provides for MANDATORY nontaxable treatment if transaction satisfies the following requirements: 

Property transferred
Take back stock 
Control corp immediately after exchange (>80%) 

When would a transferor want to fail the 351 requirements?

Recognize loss (dump loss property)
Recognize gain (tax rate increase)
Net Cap Gains to losses
Step Up Basis (transfer gifts)

What is excluded from property in section 351?

services rendered

If there are services rendered, the taxpayer must recognize the FMV of any consideration received for compensation of services rendered as:

ordinary income

How does the corporation treat services rendered? 

Sect 162 Ordinary Compensation Expense Deduction 

What is included in stock

Common and Preferred Stock

What is excluded from stock?

Nonqualified PS
Stock rights
Stock warrants

How is debt and other non equity securities received from the corporation treated?

BOOT

Boot always has a basis of ;

FMV

Boot carries ___ away

basis

Basis in stock=

Substitute basis + gain recognized - FMV Boot received

Control means the person(s) transferring the property must have at least ___ and __ immediately after exchange

80% stock ownership of the total voting power of corp
80% of total number of shares in all other classes of stock

control test can apply to several taxpayers if they are all parties in a:

integrated transaction 

What must be included to be an integrated transaction?

within the year or previously determined with transfers executed with orderly procedure

People that provide services to a corporation in exchange for stock are included in the control test transferring group as long as the service provider transfers: (2)

property with a FMV of at least 10% of the FMV of services provided to the corporation
AND transfer a minimum amount of property relative to the amount of stock already owned to be in control group

What is the bright line test?

10% of FMV of the services provided

The bright line test is a:

revenue procedure 77.37 (not in the code)

Under IRC (a), postpone a gain or loss until the shareholder/transferor: 

disposes of the stock in a taxable transaction (which impacts the basic computations)

Basis of stock to shareholder =

substitute basis
+ gain recognized on the exchange
- boot received (including liabilities)

Basis of property to corporation=

Carryover basis
+ gain recognized by transferor

Under IRC 351(a), basis in stock when giving services =

FMV services

Whenever the aggregate basis of assets transferred exceeds their fair market value, then the corporate basis in the loss property is: 

stepped down 

The step down basis is allocated ___ among assets with the built in loss

proportionately

Step down basis proportionate basis =

[(Build in loss #1) / (Total built in loss)] x (net built in loss)

If both shareholder and corp elect, the basis reduction can instead be made to the shareholders stock (in stead of stepping down property), making stock basis=

substitute basis - net built in losses

The option election allows the ___ to choose who recognizes loss in the future 

taxpayer 

Generally, when party A assumes the liability of party B, party B is treated as having received:

boot

IRC ___ provides that when the acquiring corporation assumes a liability or takes property subject to a liability in a section 351 transaction, the transfer does NOT result in boot to the transferor/shareholder for gain recognition purposes

357(a)

IRC 357(a) means liabilities assumed by corp the transfer:

does not result in boot

Under IRC 357(a), stock basis is reduced by ___ assumed by the corp

liabilities (except AP)

Shareholder basis in stock (with liabs) = 

Substitute basis 
+ gain recognized 
- Boot received (including liabilities assumed from transferor) 

Realized gain (with liabs)=

FMV of property received (including boot)
+ liabs assumed FROM transferor
- tax basis of property given up
- FMV of boot paid
- liabs assumed BY transferor

What are the two exceptions to IRC 357(a)

Tainted liabs
Liabs > Property AB

IRC ___ provides that if the principal purpose of the assumption of the liabilities is to avoid tax OR if there is no bona fide business purpose behind the exchange, the liabilities are treated as BOOT (one tainted liab taints ALL others)

357(b)

IRC ___ provides that if the sum of the liabs transferred to the corporation exceeds the adjusted basis of the properties transferred, the excess is taxable gain 

357(c )

How are tainted liabs treated

liabs = boot recieved

How are liabs that are greater than AB of properties treated

excess is taxable gain

The holding period for stock received in exchange for capital of section 1231 assets includes the: 

holding period of the property transferred to the corporation 

The holding period for stock received in exchange for any other property begins:

on the day after the exchange

The corporations holding period is the holding period is the:

holding period of the transferror/shareholder

When no gain is recognized in a section 351 transaction, the ___ do not apply

dep recapture rules 

Even through there is no gain recognized in a section 351 transaction, the dep recapture rules do not apply… any ___ associated with the property carries over to the corporation as it steps into the shoes of the transferor/shareholder for purposes of basis determination 

recapture potential 

Corporations basis in property received from shareholders =

carryover basis

Corporations recognize neither gain nor loss when it receives ___ from shareholders (whether in exchange for corporate stock or not)

neither gain nor loss

Corporations do NOT recognize income related to the capital contributions of: (ex donations) 

non shareholders

Corporation basis in property received from non shareholders (think donations) = 

$0

General rule for when a non shareholder donates MONEY to a corporation:

the basis of any property acquired with the money during a 12 month period is reduced by amt of contribution

For donations of money from a non shareholder, any money received over the cost of the new property reduces the basis of other property in the following order:

Depreciable property
Property subject to amortization
Property subject to depletion
All other remaining properties

If the amount of cash received from a non shareholder is LESS than the cost of new assets, then apply the donated cash to the purchased assets in the order from above:

Depreciable property
Property subject to amortization
Property subject to depletion
All other remaining properties

When you reduce the property based on the contributions of cash from non shareholders, it is done to ensure 

economic gains are built in 

IRC ___ permits ordinary loss treatment for losses on the sale of small business corporation stock

1244

Gains on sale of 1244 stock remains:

capital

What are the rules for 1244 (how do you qualify for section 1244) (4)

Qualified small business corporation (total amount of stock offered at date of issuance must be <1mil)
Original holder of stock
Individual
Ordinary loss deduction limited in any one year to 50,000 single (100,000 MFJ)

Why is Section 1244 a tax utopia? 

Incentivizes forming and funding small businesses because gains are capital and losses are ordinary 

For 1244, 351 contributions to corps are generally valued at their ___ for purposes of the $1 million limitation (not at FMV which is beneficial)

Adjusted Basis

How do you qualify as a small business corporation?

Total amount stock offered at date of issuance must be <1mil

If a corporation issues 1244 stock in exchange for property that has an adjusted basis>FMV (as part of 351 transaction, with loss property given), then for purposes of determining the ordinary loss, the stock basis is:

reduced to the FMV of the property

a corporate liquidation exists for tax purposes when a corporation: 

ceases to be a going concern 

Liquidations generally produce ___ treatment to the shareholders and the corporation

sale or exchange

The tax effects of liquidation are similar to that of

qualifying stock redemptions

liquidations impact (3)

corporations
shareholders
subsidiary situations

IRC ___ generally provides that a liquidating corporation recognizes gain or loss on the distribution of property in a complete liquidation 

336

For section 336 complete liquidation, property is treated as if:

they were sold at FMV (aka FMV - AB)

For section 336, when distributed property is subject to a liability, the deemed FMV may not be less than the amount of the liability (same rules as non liquidating property distributions) which means you replace the:

FMV with Liabilities

stuff all losses into a corporation and then liquidate- distributing the property back out

stuffing

IRC 351 provides for no gain or loss recognition on the transfer of property to a corporation and carryover and substitute basis rules apple unless: 

there is a built in loss on contributed property 

What are the two loss limitation (anti-stuffing) provisions

Related Party Loss Limitation
Built in Loss Limitation

For related party loss limitations, losses are disallowed on distributions what two cases

Not Pro Rata
Disqualified Property

distribution where each shareholder recevies their share of each corporate asset

pro rata distribution

property that is acquired by the liquidating corporation in an IRC 351 transaction, or as a contribution to capital, during the 5 year period ending on the date of distribution 

disqualified property 

For disqualified property, there is no requirement that the property have a built in loss at the time of its:

transfer to corporation

Related parties have ___ ownership

80%

Related persons included in the ownership % of related parties:

spouse
children
siblings
grandchildren
parent
partnerships
estates
trusts
corporations (when owner holds >50%)

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