Corporate Taxation Outline

Corporate Tax Outline
 
I. Introduction
 
I.                    Judicial Doctrines (pp. 11-13): Amorphous judicial creations, cannot be narrowly defined, designed to create skepticism in tax practice. All are closely related.
a.       Sham transaction- a transaction that never actually occurred but is represented by the taxpayer to have transpired – with favorable tax consequences of course
                                                   i.      Borderline fraud, reserved for egregious actions
b.       Economic substance doctrine- whether there is a purpose other than tax benefits and economic substance to the transaction
c.        Substance Over Form- try to figure out what really happened regardless of how it is portrayed by the taxpayer
d.       Business Purpose- why is the taxpayer doing something, is there a business reason, or just a motive to obtain a tax benefit (unless congress has encouraged such action)
e.        Step Transaction Doctrine- look at broader picture, see if seemingly separate transactions are really one, step transactions together and treat as one for tax purposes (because they are part of the same overall plan)
f.        Generally, substance controls over form, except when it doesn’t.
                                                   i.      Entity classification used to focus on substance over form, now there is the “check the box” approach, which is form over substance
                                                  ii.      Bollinger case- even though corporation was a puppet it was treated as a separate entity, citation to Moline Properties
g.        Codification of judicial doctrines =>
                                                   i.      Pros:
1.       Consistency
2.       Revenue raiser
                                                  ii.      Cons:
1.       Would interfere with bona fide business transactions
2.       Already sufficient flexibility under the common law
II.                  “C” Coporation Overview =>
a.       Sperate legal entity => taxpaying entity (different for S corporations)
b.       Corporate taxable income = gross income – deductions
c.        Calculate “gross income,” subtract deductions = taxable income (§ 63)
                                                   i.      §61- gross income is all income from whatever source derived
d.       “C” Corpration tax rates =>
                                                   i.      Range from 15 – 35% => 35% flat rate once you get to $10 million of income
1.       Smaller corps get benefit of lower rate brackets
                                                  ii.      Interaction of corporate and individual rate => historically both rates have fluctuated; TODAY => they are exactly equal
1.       Talk of lowering the corporate rate => incentive to use the corporate structure and retain earnings
III.               Comparing the taxation of corporations and individuals
a.       Presently =>no capital gains preference for corporations (1201)
                                                   i.      35% tax on net capital gain
                                                  ii.      However, corporate capital losses still off-set capital gains
b.       Corporations cannot take advantage of…
                                                   i.      Personal expenses (deductions for medical expenses)
                                                  ii.      Standard deduction
                                                iii.      Personal exemption
                                                iv.      2% floor or overall limitations of miscellaneous deductions
c.        No above the line/ below the line distinction in the corporate world => There is no “adjusted gross income,” just gross income
d.       No issue of personal expenses
e.        Better treatment of investment expenses
                                                   i.      No personal oriented deductions/ exemptions
f.        *Dividends received deduction => (DRD)
                                                   i.      Triple taxation =>
1.       subsidiary => parent => dividend
a.       tax paid on all three levels
                                                  ii.      § 243 => when certain ownership requirements are satisfied, the corporate recipient of a corporate dividend is allowed a deduction
1.       70%, 80%, and 100% => dividend received deductions
2.       Ameliorates triple taxation
g.        Corporations usually must use accrual method of accounting => include the income when you have the legal right to the income (same for deductions)
IV.                Because of the “double tax” on corporate income (taxation and corporate and shareholder level), corporations often prefer to pass on gain to shareholders in forms other than dividends that will avoid taxation at the corporate level => “self help”
a.       Company can give excludable fringe benefits which are deductible at the corporate level (SEE PROBLEM SHEET)
                                                   i.      § 79- group term life insurance ($50,000/ employee untaxed to the individual)
                                                  ii.      § 105(a), (b) – amounts received under accident health plans
                                                iii.      § 106 – contributions by employer to accident health plans
                                                iv.      § 119- meals or lodging furnished for the convenience of the employer
b.       Can make shareholder an employee (though must be legitmate) and pay them a salary, which will be deductible under § 162.
c.        § 162(a)(3)- rental payments
                                                   i.      Lease property to the corporation, which will then have to pay an arm’s length rent
                                                  ii.      Have to be wary of judicial doctrines, substance over form, if pay too high of a rent
d.       §163- interest paid on indebtedness
                                                   i.      Individuals make a loan to the corporation and receive interest which is deductible at the corporate level
                                                  ii.      Create a mix of debt and equity instead of straight equity
                                                iii.      Do not want to overleverage either, because you may get into debt/equity recharacterization, when the IRS comes in and says what you really have is equity (substance over form)
e.        Could also just elect to be an S Corp
                                                   i.      Income will pass through shareholders directly and there is no corporate level of tax to be avoided
V.                  Tax Shelters
a.       Huge losses for tax purposes that have no economic loss attached to them
                                                   i.      Nothing happening economically
                                                  ii.      Risk is either taken out completely or only very small just to argue for legitimacy
b.       Everything will technically go along with the code, but if you apply any of the judicial doctrine a court will not respect them
c.        Tax shelters are sold as products
d.       Ask, “would anyone in their right mind do this if there was not a tax benefit?”
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
BIRTH OF “C” CORPORATIONS
 
II. Corporate Formation
 
I.                    § 351 Nonrecognition Transfers
a.       § 351(a) provides that no gain or loss shall be recognized if property transferred meets three basic requirements:
                                                   i.      One or more “persons” (including individuals, corporations, partnerships and other entities) must transfer “property” to the corporation
1.       property is defined broadly to include almost anything other than services
                                                 ii.      The transfer must soley be in exchange for stock in the corporation; and
                                               iii.      The transferor or transferors, as a group, must be in “control” of the corporation “immediately after the exchange.” (Control defined in 368(c))
b.       Viewed as a mere change in the form of investment
                                                   i.      similar to § 1031 like-kind exchanges
                                                 ii.      policy => administrative feasibility; encourage corporate formation
c.        § 368(c)- “control” is defined as:
                                                   i.       “the ownership of stock possessing at least 80 percent of the total cobined voting power of all classes of stock entitled to vote and
                                                 ii.      at least 80 percent of the total number of shares of all other classes of stock of the corporation.”
1.       Look to the “control group”
2.       freedom of ownership, no restriction of action. Intermountain Lumber Co
3.       Preexisting stock ownership counts for control (“immediately after transfer”)
a.       Old stockholder must contribute again for preexisting stock ownership to count
b.       At some point, contribution will be so insignificant that preexisting ownership will no longer count
4.       Ownership of stock owned through a subsidiary does not count for this purpose (no attribution applies)
d.       351(g) – “Solely for stock”
                                                   i.      Debt securities received in a 351 transaction are treated as boot
                                                 ii.      Only stock qualifies for non recognition treatment under 351
                                               iii.      Debt-like preferred stock is treated as boot under 351 => non-qualified preferred stock
1.       However, this is still counted for purposes of the control requirement => doesn’t taint the transaction for everyone else
e.        The Transfer
                                                   i.      The exchanges do not have to be simultaneous. 
                                                 ii.       Reg. §1.351-1(a)(1) specifies the transferors must proceed with an expedition consistent with orderly procedure.
                                               iii.      Reg1.351-1(a)(2) ex 1 => look at the transferring group collectively
                                               iv.      Multiple transferors making transfers at different times: Does not matter if and when transferor subsequently transfers shares as long as at the time of transfer he had freedom of ownership over the shares with no restrictions, as long as not part of a preconceived plan that is a binding obligation. Intermountain Lumber Case.
1.       integrated plan
f.        At the corporate level, § 1032(a) provides that a corporation shall not recognize gain or loss on the receipt of money or other property in exchange for its stock (including treasury stock).
                                                   i.      Protects the corporation from tax recognition whether or not the transaction qualifies for 351
g.       Basis
                                                   i.      § 358(a)(1) provides that the transferor’s basis in the stock will be the same basis of the property transferred to the corporation
                                                 ii.      § 362(a) generally prescribes a transferred basis– i.e., the corporation’s basis in any property received in a § 351 exchange. The asset’s basis is the same as the transferor’s basis, thus preserving the loss inherent in the asset for later recognition by the corporation.
1.       362(e) – Loss property – See Below – FMV basis
h.       Holding period
                                                   i.      Transferor: § 1223(1) provides that where a transferor reveives property with an “exchanged basis” such as stock in a 351 exchange, the holding perod of that property is determined by the period during which he held the transferred property if the if the property has “the same basis in whole or in part,” and the transferred propertty is a capital asset (under 1221) or a section 1231 asset; if it is not, the transferor’s holding period begins on the date after the exchange.
1.       inventory is not a capital asset or a 1231 asset
                                                 ii.      Corporation: § 1223(2) provides that if property has a transferred (i.e. carryover) basis to the corporation, the transferor’s holding period will also transfer (tacked holding period)
                                               iii.      Holding period- Rev Ruling, 70-598 day of acquisition is excluded and the day of disposition is included
                                               iv.      Rev. Ruling 85-164, holding period proportionate for each share of stock received, “split holding period” (we will never have to calculate this in class because it is rare, you only have to hold the stock for more than a year which most people do)
i.         Limitations on transfer of built in losses- § 362(e)(2) (also applies to S corporartions)
                                                   i.      If property with a net-built in loss is transferred to the corporation in a Section 351 transaction or as contribution to capital, the transferee corporation’s aggregate adjusted basis of such property is limted to the fair market value of the transfer property immediately after the transfer.
                                                 ii.      If multiple properties are transferred in the same transaction, some with built in gains and some with built in losses, the basis limitation only applies when there is a net built in loss
1.       If more than one property with a built in loss is transferred, the aggregate reduction in basis is allocated among the properties in proportion to their respective built in losses immediately before the transaction. 362(e)(2)(B).
2.       shuts down double deduction of losses (still single deduction)
                                               iii.      Netting occurs transferor to transferor (do not net all property transferred by all parties) Reg. 1.362-4(b)(2)
                                               iv.      JOINT ELECTION => Or could elect to have stockholder’s basis be FMV, and loss would be preserved on the corporate side but not duplicated on the stockholder’s side. 362(e)(2)(c) [both corporation and transferor must agree; one party’s basis has to be fmv and the other’s should be the transferred basis]                                                  v.      § 362(e)(2) proposed regs seem to sanction the approach of allocating the basis to the asset from which that gain arose. (p. 77 in book)
1.       Each separate asset is given its original transferred basis and then increased by the amount of gain recognized by the transferor on that asset.
j.         Transfer of installment notes
                                                   i.      § 453B(a) requires the recognition of gain realized upon the disposition of an installment obligation (difference between basis and amount realized or FMV at time of sale). 
                                                 ii.      Reg. § 1.453-9(c)(2) specifies that no gain recognition required upon the disposition of an installment obligation in a § 351 transfer.
k.       Services do not count as “property” for § 351.
                                                   i.      Reg 1.351-1(a)(1)(ii), 1(a)(2) Example 3, which states that if a person receives stock for a combination of property and services all of the stock is counted toward the 80 percent control requirement.
1.       Will not qualify under section 351 if property transferred is de minimis relative to stock received for services (less than 10% of stock value). Reg 1.351-1(a)(1)(ii)
2.       Property received will not be considered to be of “relatively small market value … if the fmv of the property is equal to, or in excess of, 10 percent of the fmv of the stock already owned (or to be received for services).” Revenue Procedure 77-37.
l.         §351 applies to S corps and C corps equally with the same restrictions.
                                                   i.      § 1371- C Corp provisions generally apply to S Corps (SEE S CORP SECTION)
 
II.                  Treatment of Boot in § 351 transactions
a.       Generally
                                                   i.      Section 351(b) provides that if an exchange would otherwise have qualified under § 351(a) but for the fact that the transferor received “other property or money” in addition to stock, then the transferor’s realized gain (if any) must be recognized to the extent of the cash plus the fair market value of the other property received.
1.       Anything that is not stock is boot under § 351(b)
                                                 ii.      No loss may be recognized under § 351(b)
                                               iii.      Note => you never recognize more gain than you realize
                                               iv.      Purpose => Changing not merely the form of investment but the substance as well. To that extent, nonregcognition treatment is appropriate.
1.       In nonrecognition situations, you are seen as merely continuing your investment in a different form. However, the receipt of boot is seen as a partial disinvestment on which you should pay tax.
b.       Rev. Rul. 68-55  (p. 75): Determining the gain amounts, etc.,  when receiving boot (§351(b)):
                                                   i.      Asset-by-asset allocation approach.
                                                 ii.      Allocation of the boot consideration on a relative fair market value of assets basis.
                                               iii.      No loss recognition permitted; no netting.
                                               iv.      Divided holding period for stock received.
                                                 v.      Asset tax bases to corp. adjusted for boot.
                                               vi.      Gain recognized to the extent of boot
                                             vii.      NOTE => character of the gain or loss depends on the character f the transferred asset
                                           viii.       
c.        Basis
                                                   i.      If a shareholder recognizes gain as a result of the receipt of boot, the shareholder may increase his basis in the stock, securities and other property received by an amount equal to the gain recognized on the transfer. § 358(a)(1)(B)(ii).
                                                 ii.      The basis of the nonrecognition property is thus an exchanged basis, increased by the gain recognized on the transfer, and, finally decreased by the FMV of the boot (including cash) received. § 358(a)(2)
1.       Prevents double taxation and will result in less gain (or more loss) if and when the shareholder later sells the property received.
2.       Unrecognized gain remains in the stock
                                               iii.      Stock Basis Calculation when “Boot” is Received §358(a)(Basis to Distributee/transferor).
1.       Tax basis of the transferred asset
2.       Less:  FMV of the boot received
3.       Plus:  Amount of gain recognized
4.       Equals:  Basis to the transferee shareholder of the stock received.
                                               iv.      The boot is assigned a FMV basis and the remaining basis is allocated to the nonrecognition property
1.       Basis where several assets are exchanged – If a transferor exchanges several assets in exchange for stock and boot, it becomes necessary to allocate the boot among the transferred assets based on their relative fair market values. Reg. 1.358-2(b)(2)
                                                 v.      At the corporate level, § 362(a) provides that the corporation’s basis in the property received on a § 351 exchange is the same as the transferor’s basis increased by any gain recognized on the exchange. [Corporation’s basis = Carryover basis + gain recognized by the transferor (any gain)] 1.       Multiple assets: Divide according to FMV (there is no code provision for this, though new proposed regs suggest this approach)
d.       Transfer of Depreciated Property: § 1245 gain recapture delayed 1245(b)(3)
e.        ***Assumption of Liabilities: § 357
                                                   i.      In most circumstances, a taxpayer who is relieved of debt in connection with the disposition of property must include the debt relief in the amount realized even if the debt is non-recourse. Crane v. Commissioner.
                                                 ii.      United States v. Hendler (S.Ct. 1938)- the assumption and subsequent payment of the transferor’s liabilities by a transferee corporation constitutes boot to the transferor.
1.       Superseded by enactment of Section 357
                                               iii.      *§ 357(a)- the assumption of a liability by a transfer corporation in a Section 351 exchange (and several other transactions) will neither constitue boot nor prevent the exchange from qualifying under Section 351.
1.       Recognition of any gain attributable to the relieved liabilities is postponed by a reduction of basis in stock received
2.       note: 357 done on an aggregate basis
                                               iv.      § 358(d) reduces the basis in the stock received in exchange by treating the relieved liabilities as “money received” by the transferor for purposes of determining the shareholder’s basis ONLY.
1.       Treated as money received just for purposes of this section
2.       Does not matter whether the assumption of liability resulted in gain or loss. 1.358-3(a)
3.       Corporate Basis in Property – transferred basis + Gain recognized (allocated in proportion to FMV)
a.       Another approach => allocate only to gain property (do what makes sense)
                                                 v.      Exceptions to Section 357
1.       § 357(b) “tax avoidance motive” exception- the assumption of a liability is treated as boot if the taxpayer’s “principal purpose” in transferring the liability was the avoidance of federal income taxes OR was not a bona fide business purpose.
a.       E.g. taking out a loan on the property right before transfer for personal reasons
b.       IF ONE LIABILITY FAILS, THEY ALL FAIL
2.       ***§ 357(c)-Liabilities in Excess of Basis =>  if the sum of the liabilities assumed by the corporation exceed the aggregate adj