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Corporate Income Tax
Santa Clara University School of Law
Hasen, David M.

Corporate Tax – David Hasen – 2013

Formation

Triggering Facts:

– A new corporation is formed

– Persons transfer property in exchange for stock of the new corps

Essence of 351: to ascertain whether a transferor has a continuing relationship w/ the property transferred to a corporation sufficient to justify non recognition treatment or whether the transferor has severed the relationship with the transferred property, justifying recognition.

Policy: The reason for 351 is to ensure continuity of investment

1. Does the transaction qualify for 351/1032? (if so, TP defers recognition of g/l) (If notà check for non-taxable 368 treatment)

-351 can apply to both formation of a new corp and to a transfer of an existing corp.

351(a): No gain or loss shall be recognized if 1) property is transferred to a corp by one or more persons 2) solely in exchange for stock in such corp and 3) immediately after the exchange such person or persons are in control (as defined in 368(c)) of the corp.

Section 351 applies only if the transferor (not elective):

1. Transfers property to a corp.

a. Property does not include the transfer of future personal services- 351(d)(1)

i. Does transferor X’s contribution consist of a nominal amount of property? (RR 77-37 transfer of property of at least 10% is NOT NOMINAL –look at proportion)

1. If no, satisfies Reg. 351-1(a) and will not affect control

2. If yes, X’s stock from NewCo will not be included in control test (argue for Bus. Purpose of other prop if within proximity of 10% rule)

2. Receives stock in exchange; AND

a. Debt is not qualified nonrecognition property- implied by 351(a)

3. ***Along with other transferors, if any, controls the corp immediately after the exchange. ***

a. Control

i. 368(c)- Transferors control a Corp only if they own at least 80% of total combined voting power of all classes of the corp’s voting stock; AND at least 80% of total number of each class of Corps nonvoting stock shares- Rev Rule 59-259

b. Immediately After (When the Dust Settles)

i. Transferors must be acting in concert in a single integrated plan

1. Transfers need not be simultaneous

2. The transfer must be mutually independent steps in the formation and carrying on of the business

Note: If a transferor sells his newly received stock to a 3rd party immediately after the transaction pursuant to a plan prior to the 351 transaction, that stock wont be attributed to the transferor in testing for control.

2. What are the Tax Consequences to the Transferor (shareholders)?

a. 351- Will the Transferor Recognize Gain?

i. The person recognizes no gain or loss if she receives SOLELY transferee-corp stock in the exchange. 351(a)

ii. If the person receives other property (BOOT) in addition to transferee-corp stock, she still recognizes NO LOSS BUT RECOGNIZES ANY REALIZED GAIN UP TO THE BOOT’S FMV. (Nonqualified Preferred Stock is treated as boot under 351(g))

1. NQPS- must be preferred stock under (g)(2)(A) and must be limited and preferred as to dividends and not participate in corporate growth to any significant extent

EX. T transfers an asset with 6k a/b and 20k FMV to XCo in exchange for 15k of X stock and 5k of Cash

a. T realizes 14k gain, but only recognizes a 5k gain the smaller of 5k (the boots value) and 14k (the realized gain)

b. Although T may prefer to treat the cash as a return of T’s original $6k investment in the property, 351b requires recognition of gain before basis can be recovered.

NOTE: When transferor transfers multiple properties in exchange for stock in NewCo and BOOT- Rev Rule 68-55

1. Use the asset-by-asset approach (as if transferor transferred each prop separately)

2. Need to figure out the amount of gain to be recognized under 351(b) (note: loss properties do not recognize gain)

Asset 1

Asset 2

Asset 3

FMV of Asset

22

33

55

% of total FMV

20

30

50

FMV of Y stock

20

30

50

Cash Received

2

3

of property that has been exchanged for NewCo stock and boot, is treated as receiving a ratable share of the NewCo stock and Boot in the transaction

a. Policy: Don’t offset loss property with gain

c. What is Transferor’s Holding Period of NewCO Stock?

i. 1223(1)- The Holding Period tacks if:

1. If the transferor takes an exchanged basis in the property

2. The property surrendered was a capital asset, or 1231 asset.

a. Inventory DOES NOT TACK otherwise it would be a way for a transferor to convert inventory to capital gain

i. Must hold stock for more than a year to get LTCG treatment of the inventory

ii. Policy: The Holding Period is important in determining the treatment of capital gain or loss as short or long term on a later disposition of a qualified stock.

3. What are the Consequences to the Transferee Corporation?

a. 1032- Will the Transferee-Corp Recognize Gain?

i. Corporation Recognizes no Gain or Loss on the property it receives in exchange for its stock. 1032(a)

1. **Under general principles, a corp. also recognizes no gain or loss when it acquires property for cash, its debt, or the assumption of the transferor’s liabilities; however, if a transferee corp. transfers boot in the 351 it may recognize gain but not loss- 351(f)

2. **A transferee Corp must recognize gain if it transfers appreciated noncash property equal to the excess of the property’s FMV over its adjusted basis (Basically saying transferee must recognize gain on boot it gives to transferor)

b. 362 – What Basis Does Transferee-Corp Take in Property Received from Transferor?

i. 362(a) the transferee-corp generally takes a basis in the prop transferred equal to the transferor’s basis + any gain recognized by the transferor under 351(b) and 357(c)(1)