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Corporate Formations Tx 8120

Corporate Formations Tx 8120. Goals to Achieve. You should be able to:. Calculate ____ or ____ from transfers to controlled corporations, Explain _____ and _______ period implications from such transfers, Determine tax consequences of contributions to ________, and

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Corporate Formations Tx 8120

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  1. Corporate FormationsTx 8120

  2. Goals to Achieve You should be able to: • Calculate ____ or ____ from transfers to controlled corporations, • Explain _____ and _______ period implications from such transfers, • Determine tax consequences of contributions to ________, and • Explain deductibility of ______________ expenditures and ________ costs.

  3. Fundamental Tax IssuesTransfers to Controlled Corporations Shareholders Control Property Stock Corporation Shareholder (_________) Issues Corporation (__________) Issues 1. How much gain or loss do shareholders _______________? 2. What _______ do shareholders take in ______ received? 3. When does the ___________ period begin in the _________ received? 1. How much gain or loss does the corporation ____________? 2. What _______ does the corporation take in the __________ received? 3. When does the corporation’s __________ period begin in the ___________ received?

  4. Transfers to controlled corporations Shareholder issues Gain or loss recognized Section 1001 (a) Computation of gain or loss. The gain from the sale or other disposition of property shall be the excess of the amount realized … over the adjusted basis …, and the loss shall be the excess of the adjusted basis …over the amount realized. … (c) Recognition of gain or loss. Except as otherwise provided in this subtitle, the entire amount of the gain or loss … on the sale or exchange of property shall be recognized.

  5. Transfers to controlled corporations Shareholder issues Gain or loss recognized Section 351(a) (a) General rule. No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation. Rationales: (1) Continuation of (2) Re gains, (3) Re losses,

  6. Transfers to controlled corporations Shareholder issues Gain or loss recognized Section 367(a)(1) (a) Transfers of property from the United States. (1) General rule. If, in connection with any exchange described in section 332, 351, 354, 356, or 361, a United States person transfers property to a foreign corporation, such foreign corporation shall not, for purposes of determining the extent to which gain shall be recognized on such transfer, be considered to be a corporation.

  7. Transfers to controlled corporations Shareholder issues Gain or loss recognized Property condition What Is Property? • Cash • Accounts receivable • Inventory • Equipment • Real estate • Intangibles No gain results from transferring cash. So, does it matter whether cash is considered “property”?

  8. Transfers to controlled corporations Shareholder issues Gain or loss recognized Property condition Hempt Brothers, Inc. v. US(CA-3, 1974) A ___ method partnership incorporated under §351, transferring accounts receivable with a ___ basis. Taxpayer insisted such receivables are not “______” under §351 and, thus, represent gross income to the partnership when transferred or collected. Alternatively, the taxpayer argued that the assignment of income doctrine controls. The IRS countered that receivables are ______ for which the corporation takes a transferred basis of ____ and become gross income to the new corporation when collected. Partnership 100% Shares Hempt Bros., Inc.

  9. Transfers to controlled corporations Shareholder issues Gain or loss recognized Property condition Hempt Brothers, Inc. v. US(CA-3, 1974) In siding with the gov’t, the court found no reason to narrowly construe “_______” and believed that the §351 purpose to facilitate the incorporation of ongoing businesses trumps any assignment of income concerns. Further, the court noted that §358 did not increase the basis of shares received because of the ____ basis receivables. Thus, gross income attributable to the receivables is merely deferred. Partners 100% Shares Hempt Bros., Inc.

  10. Transfers to controlled corporations Shareholder issues Gain or loss recognized Property condition Section 351(d) (d) Services, certain indebtedness, and accrued interest not treated as property. For purposes of this section, stock issued for-- services, Indebtedness of the transferee which is not evidenced by a security, or Interest on indebtedness of the transferee corporation which accrued on or after the beginning of the transferor’s holding period for the debt, shall not be considered as issued in return for property.

  11. Transfers to controlled corporations Shareholder issues Gain or loss recognized Property condition Example: Stock for Services Bart drafts and files articles of incorporation for Al’s business and bills Al $3,000. Al transfers his business assets to the new corporation. Of 100 authorized shares, Bart receives 10 for his work, and Al receives 90. What are the tax consequences to each individual? Would the results change if Bart and Al receive 25 and 75 shares, respectively? Al (owner) Bart (attorney)

  12. Transfers to controlled corporations Shareholder issues Gain or loss recognized Property condition How Much Property? • For §351 to apply, “_________” must control the corporation afterwards. • Generally, a person contributing property and services is a “_________” whose total shares count toward control requirement. • So, why not have service providers contribute ________ property?

  13. Transfers to controlled corporations Shareholder issues Gain or loss recognized Property condition How Much Property?(continued) • Nominal property transfers used ________ to qualify other transferors under §351 are ________, Reg. §1.351-1(a)(1)(ii). • Transfers avoid nominal label if FMV of contributed property ≥ ___% of FMV of stock previously owned and received for ________, Rev. Proc. 77-37, §3.07.

  14. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition What Is Stock? • Can be _____ or _________ • Can be ______ or _________ • Does not include: • Stock ______ • Long-term _____ securities • ___________ preferred Shareholders Control Property Stock Corporation

  15. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Nonqualified Preferred, §351(g) • Preferred stock • Limited and preferred as to ___________ • Doesn’t significantly participate in _______ • Nonqualified • Holder has right to require ___________, • Issuer is required to ________ shares, • Issuer has right to ________ and, on issuance date, is more likely than not to ________, or • Dividend rate ______

  16. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Section 351(b) (b) Receipt of property. If subsection (a) would apply to an exchange but for the fact that there is received, in addition to the stock permitted to be received under subsection (a), other property or money, then-- (1) gain (if any) to such recipient shall be recognized, but not in excess of-- (A) the amount of money received, plus (B) the fair market value of such other property received; and (2) no loss to such recipient shall be recognized.

  17. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Receipt of Boot Shareholders Stock plus Boot Property Corporation ____ of stock and boot received - Adjusted of property transferred _________ gain (a) (b) _________ gain = Smaller of:

  18. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Rev. Rul. 68-55 Corp X (shareholder) FMVBasisOther Asset I $ 22 $ 40 LTCL Asset II 33 20 STCG Asset III 55 25 §1245 Y stock (FMV $100) and $10 Corp Y (newly organized) Issues Y stock (FMV $20) Does X calculate gain on ______ or ___________ basis? If determined on _______ basis, how does X determine what it receives for each _______? $20 Individual A (shareholder)

  19. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Rev. Rul. 68-55(continued) Corp X (shareholder) FMVBasisOther Asset I $ 22 $ 40 LTCL Asset II 33 20 STCG Asset III 55 25 §1245 Y stock (FMV $100) and $10 $110 - $85 = $25 gain Corp Y (newly organized) Y stock (FMV $20) Overall or Separate? $20 • Each asset is ________ exchanged: • No _______ of gains and losses • _______________ analysis Individual A (shareholder)

  20. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Rev. Rul. 68-55(continued) Corp X (shareholder) FMVBasisOther Asset I $ 22 $ 40 LTCL Asset II 33 20 STCG Asset III 55 25 §1245 Y stock (FMV $100) and $10 Corp Y (newly organized) Y stock (FMV $20) Amount Realized? $20 • Need amount realized for each asset: • Based on _________ ____ • Compute _____ and ____ separately Individual A (shareholder)

  21. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Rev. Rul. 68-55(continued) Corp X (shareholder) Asset Asset Asset Total I II III FMV of asset $110 $22 $33 $55 Percent of total FMV of: Y stock received Cash received Amount realized Basis of asset Gain (loss) realized Gain (loss) recognized FMVBasisOther Asset I $ 22 $ 40 LTCL Asset II 33 20 STCG Asset III 55 25 §1245 Y stock (FMV $100) and $10 Corp Y (newly organized) Y stock (FMV $20) Thus, Corp X recognizes $__ short-term capital gain and $__ ordinary income. $20 Individual A (shareholder)

  22. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Section 357(a) (a) General rule. Except as provided in subsections (b) and (c), if-- (1) the taxpayer receives property which would be permitted to be received under section 351 … without the recognition of gain if it were the sole consideration, and (2) as part of the consideration, another party to the exchange assumes a liability of the taxpayer, then such assumption shall not be treated as money or other property, and shall not prevent the exchange from being within the provisions of section 351 ….

  23. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Section 357(b) (b) Tax avoidance purpose. (1) In general. If … it appears that the principal purpose of the taxpayer with respect to the assumption described in subsection (a)-- (A) was a purpose to avoid Federal income tax on the exchange, or (B) if not such purpose, was not a bona fide business purpose, then such assumption (in the total amount of the liability assumed …) shall, for purposes of section 351 …, be considered as money received by the taxpayer on the exchange.

  24. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Attempted Bail Out Objective: Pete needs $100. He owns unencumbered realty (FMV $100, basis $25) he’d like to sell, but he doesn’t want to recognize gain. Strategy: Borrow $100 on nonrecourse mortgage, transfer encumbered realty to 100%-owned corporation, and let the corporation pay off the mortgage. BANK Pete 100% Corporation

  25. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Section 357(c)(1) (c) Liabilities in excess of basis. (1) In general. In the case of an exchange-- (A) to which section 351 applies … if the sum of the amount of the liabilities assumed exceeds the total of the adjusted basis of the property transferred pursuant to such exchange, then such excess shall be considered as a gain ….

  26. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Debt Heavy Transfers Castle Corp 100% Serf Corp How much gain does Castle recognize?

  27. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Peracchi v. CIR(CA-9, 1998) An insurance corporation needed capital to meet state premium-to-asset ratios. So, its sole owner contributed encumbered realty for which the debt _________ the realty’s basis. To avoid §357(c) _____, the shareholder also gave the corporation his promissory note, asserting the note’s _____ equaled its face value. The IRS insisted on a _____ _____ for the note. Don Peracchi 100% Realty’s basis $ 980,000 Mortgages 1,550,000 Promissory note 1,060,000 NAC

  28. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Peracchi v. CIR(CA-9, 1998) The court noted ________ ________ ______ since, in bankruptcy, hostile creditors could recover from the shareholder. Also, the transaction was economically equivalent to the shareholder _________ cash, _________ it to the corporation, and the corporation using the cash to ____ Don’s note from the creditor. Finally, attributing a _____ basis to the note would force the corporation to recognize “________ ____” if it later sold the note. The court _________ the Tax Court, which believed the debt was not genuine, and held for the taxpayer. Don Peracchi 100% Realty’s basis $ 980,000 Mortgages 1,550,000 Promissory note 1,060,000 NAC

  29. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Section 357(c)(3) (c) Liabilities in excess of basis. (3) Certain liabilities excluded. In general. If a taxpayer transfers, in an exchange to which section 351 applies, a liability the payment of which … would give rise to a deduction … then … such liability shall be excluded in determining the amount of liabilities assumed. Exception. Subparagraph (A) shall not apply to any liability to the extent that the incurrence of the liability resulted in the creation of, or an increase in, the basis of any property.

  30. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Rationale of §357(c)(3) Creditors Cash Basis Proprietor Cash Basis Proprietor 100% 100% Assets: FMV $700 Basis 100 Payables 500 Assets: FMV $700 Basis 100 Shares: FMV $200 Cash 500 Shares: FMV $200 Corporation Corporation

  31. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Cash Basis Transferors LiabilitiesNot Liabilities Accrued wages Accounts payable for heavy machinery Repair services received but not paid Bank loan for working capital Utilities used but not yet paid Inventory bought on credit Mortgage securing land

  32. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Rev. Rul. 95-74 The manufacturing business of P, an accrual basis corporation, operated on land that hazardous waste had contaminated, resulting in _________ environmental liabilities. Under §351, P transferred the manufacturing business (including the land and its associated liability) to newly-created S, a 100%-owned, accrual basis corporation. Two years later, S began soil and groundwater remediation efforts, involving §___ and §___ expenditures. Issues Are the contingent liabilities _______ or ________ under §357(c)? Can S ______ or ________ expenditures related to these liabilities?

  33. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Rev. Rul. 95-74(continued) Holding on Issue 1 In determining whether liabilities __ ________ of transferred assets, liabilities for which P has received ___ deduction or _______ increase are ignored. Otherwise, P recognizes gain for which it receives no ___ ______. Holding on Issue 2 As incurred, S can _______ under §162 or __________ under §263 any soil and groundwater remediation costs it incurs.

  34. Transfers to controlled corporations Shareholder issues Gain or loss recognized Solely for stock condition Mapping of Liabilities • Liabilities transferred to corporations are not treated as ______ received. • Exceptions: • Tax _________ motive • Lack of __________ purpose • Liabilities __ basis in transferred assets • Subsidiary to tax ______ and _______ purpose tests • Liability ignored if transferor has not ______ or _______ item

  35. Transfers to controlled corporations Shareholder issues Gain or loss recognized Control condition Section 368(c) (c) Control defined. … [T]he term “control” means the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation. Shareholders Control Property Stock Corporation

  36. Transfers to controlled corporations Shareholder issues Gain or loss recognized Control condition Intermountain Lumber Co. v. CIR(TC, 1976) Milo Wilson 182 S&W shares in escrow Installment note Dee Shook Sawmill site 364 S&W shares S&W Sawmill (later acquired by Intermountain)

  37. Transfers to controlled corporations Shareholder issues Gain or loss recognized Control condition American Bantam Car Co. v. CIR(TC, 1948, aff’d per curiam CA-3, 1949) “Associates” transferred assets of bankrupt auto company to new corporation in return for voting _________. June 3, 1936 June 8, 1936 Associates and underwriters reached fee agreement regarding public offering of voting ___________. Associates placed all _________ in escrow, pending outcome of public offering. Aug. 1936 Associates transferred _________ stock (> 20%) to underwriters as compensation for public offering. Oct. 1937

  38. Transfers to controlled corporations Shareholder issues Gain or loss recognized Control condition American Bantam Car Co. v. CIR(TC, 1948, aff’d per curiam CA-3, 1949) Did associates have control on incorporation date? Issue: Holding: Control _______, so §351 applies. Taxpayer ______. No binding, written agreement existed with underwriters _______ incorporation. Underwriters received common only if sales ______ met. Placing common in _________ indicated ownership. Contemplating steps under general plan does not invoke ______ ___________ doctrine. Reasoning: Corporation can deduct depreciation only on the §362 ____________ basis, which is lower than ____ basis. Implication:

  39. Transfers to controlled corporations Shareholder issues Gain or loss recognized Control condition D’Angelo Associates, Inc. v. CIR(TC, 1978) Dad contributed $15,000 to new corporation, and corporation issued 10 shares each to Mom and 5 kids. June 21 June 30 Mom and Dad “sold” depreciable assets to corporation in return for $15,000, mortgages assumed, and demand note payable to Dad. Taxpayer Position Gov’t Position Dad never had ______. June 30 transaction was a ____. Sec. 351 ___________. Corporation takes __________ basis. _____ ___________ doctrine applies. Single “__________” transfer exists. Sec. 351 ________. Only _________ basis is depreciable.

  40. Transfers to controlled corporations Shareholder issues Gain or loss recognized Control condition D’Angelo Associates, Inc. v. CIR(TC, 1978) Did Dad have control on incorporation date? Issue: Holding: _______ existed, so ______ applies. Taxpayer ________. Equivalent to incorporation with depreciable assets followed by ______ of shares to family members. Incorporation and “sale” occurred almost ____________, and formed ________ parts of a single plan; incorporation was ______________ without later “sale.” No ____________ reason evident for separate transfers. Reasoning: Taxpayer can deduct depreciation only on the §362 ________ basis, which is lower than _____ basis. Implication:

  41. Transfers to controlled corporations Shareholder issues Gain or loss recognized Control condition Rev. Rul. 2003-51 Corp X (Y’s parent) Transfers #2 and #3 occur simultaneously. Corp Y (business A) Corp W (businesses A, B, C) Corp Z (formed to run combined business A)

  42. Transfers to controlled corporations Shareholder issues Gain or loss recognized Control condition Rev. Rul. 2003-51 Corp X Corp W (businesses B and C) 60% 40% Corp Y 100% Corp Z (combined business A)

  43. Rev. Rul. 2003-51 Corp X (Y’s parent) Transfers #2 and #3 occur simultaneously. Corp Y (business A) Corp W (businesses A, B, C) Corp Z (combined A) However, “a transfer of property that is followed by a ___________ _________ of the stock received … is not necessarily inconsistent with the purposes of §351.” “Courts have held that the control requirement of §351 is not satisfied where, pursuant to a _______ ________ entered into by the transferor _____ ___ the transfer of property …, the transferor [Corp _] loses control of the corporation [Corp _] by a ______ ____ of … that stock to a third party who does not also transfer property ….”

  44. Rev. Rul. 2003-51 Corp X (Y’s parent) HOLDING: _______ transfer falls under §351 since transaction can be recast to clearly meet requirements. Business A Y shares $30 Corp Y (business A) Corp W (businesses A, B, C) Corp Z (formed to run combined business A) Y shares Business A and $30 All Z shares

  45. Transfers to controlled corporations Shareholder issues Gain or loss recognized Control condition Collapse Steps If • Legally bound to complete later steps • Rationale in __________ _________ • Missing in _________ ________ ____ • Separate transfers lack business reason • Point of _________ ___________ • Transferee later disposes of shares in prearranged, taxable sale • Taxable sale absent in ____ ____ _______

  46. Transfers to controlled corporations Shareholder issues Basis of stock received Basics on Basis • Two ways to increase basis • Invest ________ • Recognize _______ • Two ways to decrease basis • Withdraw ________ • Take _________

  47. Transfers to controlled corporations Shareholder issues Basis of stock received Section 358(a) (a) General rule. In the case of an exchange to which section 351 … applies-- (1) Nonrecognition property. The basis of the property permitted to be received … without the recognition of gain or loss shall be the same as that of the property exchanged-- (A) decreased by-- (i) the fair market value of any other property (except money) received by the taxpayer, (ii) the amount of any money received by the taxpayer, and … • increased by-- (ii) the amount of gain to the taxpayer which was recognized on such exchange …. (2) Other property. The basis of any other property (except money) received by the taxpayer shall be its fair market value.

  48. Transfers to controlled corporations Shareholder issues Basis of stock received Section 358(a) Basis of ________ _______ to corporation - Boot _______ - Liabilities transferred (i.e., same as _____) + recognized Basis of _______ received from corporation Shareholders Control Property and Liabilities Stock and Boot Corporation

  49. Transfers to controlled corporations Shareholder issues Basis of stock received Rev. Rul. 68-55(extended) Corp X (shareholder) Asset Asset Asset Total I II III FMV of asset $110 $22 $33 $55 Percent of total FMV of: Y stock received $100 $20 $30 $50 Cash received 10 2 3 5 Amount realized $110 $22 $33 $55 Basis of asset 40 20 25 Gain (loss) realized $-18 $13 $30 Gain (loss) recognized $ 0 $ 3 $ 5 FMVBasisOther Asset I $ 22 $ 40 LTCL Asset II 33 20 STCG Asset III 55 25 §1245 20% 30% 50% Y stock (FMV $100) and $10 Corp Y (newly organized) What is X’s basis in stock received? Basis relinquished Boot received Gain recognized Basis of stock received Y stock (FMV $20) $20 Individual A (shareholder)

  50. Transfers to controlled corporations Shareholder issues Holding period of stock received Section 1223(1) For purposes of this subtitle-- (1) In determining the period for which the taxpayer has held property received in an exchange, there shall be included the period for which he held the property exchanged if … the property has, for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in his hands as the property exchanged, and … the property exchanged at the time of such exchange was a capital asset as defined in section 1221 or property described in section 1231.

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