Corporate Tax Slides: Chapter 2 Part A - PDF

Chapter 2 Corporate Formation  Corporate Formation General Principle – Need for Initial Operating Capital generally received by issuance of its stock or from borrowing. – Cash received for shares of stock = routine Treated as cash purchase for all intent and purpose...

Chapter 2 Corporate Formation  Corporate Formation General Principle – Need for Initial Operating Capital generally received by issuance of its stock or from borrowing. – Cash received for shares of stock = routine Treated as cash purchase for all intent and purpose – Basis of stock to shareholder is the amount of cash contributed. – Holding period begins on date of contribution – Corporations basis in Cash is the face value = cash is cash – Corporation recognizes no gain or loss on the issuance of its own shares – See Code Section 1032(a)  Corporate Formation Stock issued in exchange for property – Without special intervention there would be a taxable exchange Property contributed to Corporation would be deemed to be sold or exchanged for the stock received. Taxpayer would have gain or loss on the exchange measured by the difference between the adjusted basis of the property in the hands of the shareholder and the fair market value of the stock received. Corporation could have gain as well – Value of property received over the basis in newly issued shares (probably zero)  Corporate Formation Section 351 – Generally provides for transfers of property for stock to be “tax-free”. The non-recognition provisions. Policy reasons = mere change in form of ownership or investment. – 3 Basic Requirements One or more persons (all entities or individuals) must transfer property to the corporation The transfer must be solely in exchange for stock of the corporation The transferor or transferors, as a group, must be in control immediately after the exchange. – Control is defined for purposes of Section 351 by Section 368(c) » Ownership of the stock possessing at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation.  Corporate Formation – Results when 351 applies Shareholder recognizes no gain or loss and instead receives a “carryover or exchanged basis”. See Code section 358(a)(1) Shareholders holding period of stock is determined by including the period during which the property transferred was held if the property transferred is a capital asset or a 1231 asset; otherwise holding period begins on the day of the transfer. See Code Section 1223(1) Corporation does not recognize gain or loss on the issuance of its own stock – Section 1032 Corporation steps into the shoes of the shareholder for basis purposes – so that property received from the shareholder has the same basis inside the corporation as it had in the hands of the taxpayer – See Code Section 362(e) Section 1223(2) provides for “tacked” holding period to the corporation (carryover basis and carryover holding period)  Corporate Formation Limitations to 351 – Contributions of Loss Property Because of the carryover features of Section 351 under Sections 358, 362, 1032 and 1223. Inherent Gain in the property is preserved at both the corporate level and the shareholder level. Duplicated Gain = Double Taxation. Without a special provision – a loss could also be duplicated. – Congress learned of the abuses some taxpayers were engaging in and enacted additional provisions. » If property with a built-in loss is transferred to a corporation in a Section 351 transaction or as a contribution to capital, the corporations aggregated adjusted basis in such is limited to the fair market value of the transferred property immediately after the transfer. Applied on a transferor by transferor basis rather than on an aggregated group of transferor’s  Corporate Formation – Transferred Property has a net built-in loss when the aggregate adjusted basis of the property transferred exceeds its fair market value. – Any gain recognized on the transfer is taken into consideration to determine net built-in loss – Multiple properties contributed by the same transferor are aggregated to determine if there is a NET built-in loss. – Requires allocation of basis reduction if multiple loss properties Alternative to basis limitation – Shareholder and Corporation may jointly elect to reduce the shareholders basis in the stock that it receives to its fair market value – Basis reduction is only to extent of the amount necessary to reduce the built-in loss  Corporate Formation Problem Page 59 – A,B,C, D, E form X corporation with the following: A $25,00 Cash for 25 shares B Inventory value of $10,000, adjusted basis of $5,000 for 10 shares C Land value of $20,000, adjusted basis of $25,000 for 20 shares D Equipment value of $25,000, adjusted basis of $5,000 (after depreciation previously taken of $20,000) for 25 shares E Installment Note value of $20,000  Corporate Formation Problem Page 59 – A) What are the tax consequences (gain/loss recognized; basis and holding period in the stock received to A,B,C,D & E? – B) What are the tax consequences to X corporation (gain recognized, basis and holding period in each of the assets received?)  Corporate Formation Homework/Quiz #2 – Send me an email no later than 6PM on Wednesday September 8th with the answers to Parts C & D of the problem on Page 59