I. Corporate Formations
A. No Gain/Loss for Corporations
i. §1032(a)à a corporation shall not recognize gain or loss on the receipt of money or other property in exchange for its stock. (Including treasury stockà Reg. 1.1032-1(a))
B. Introduction to §351
i. §351(a)à At the shareholder level, no gain or loss shall be recognized if property is transferred to a corporation by one or more persons in exchange for its stock if the transferor or transferors of property are in “control” of the corporation “immediately after the exchange”.
1. Applies to transferors to newly formed and preexisting corporations. 351 is not limited to formation
2. 3 requirements:(1) Property transferors, (2) solely for stock, (3) control immediately after
3. If 351 does not apply, SH’s transfer of property would be a taxable exchange. 1001 would apply. Basis in the property minus value of the stock (presumably the same value as the property)
ii. 351 Elements (when it applies)
1. One or more persons (including individuals, corporations, partnerships, and other entities) must transfer “property” to the corporation
2. The transfer must be solely in exchange for stock of the corporation
3. The transferor or transferors, as a group, must be in “control” of the corporation “immediately after the exchange.”
iii. Property Transferors Requirement
1. Cash is property. Revenue Ruling 69-357.
2. Services rendered are not property. 351(d)(1)
a. If the stock is compensation for services, the tax consequences are determined under 61 and 83.
i. A and B form New Corp
ii. A contributes property v=80 b=30 for 80 shares. B contributes services v=20 for 20 shares.
iii. B has 20 of gain; this is not a 351 transfer. B would take a basis in property received = to amount paid + amount of GI B would have to report = 20. See §83
iv. 351 applies to A. No Gain. Basis in stock = 30.
i. A and B form New Corp
ii. A contributes property v=75 b=30 for 75 shares. B contributed services v=25 for 25 shares.
iii. B has 25 of gain. Same as above but 25.
iv. 351 does not apply to A. He fails the control requirement because B is not a property transferor and he only owns 75%.
3. Mixed: Services and Property Transferred for Stock
a. RULE: If a person receives stock in exchange for both property and service, and that transferor is deemed to be a valid property transferor, then all the SH’s stock is counted toward the 80% control requirement.
i. When testing for control you don’t just look at the % of stock they received for their property, you look at all of it.
ii. If a person qualifies as a property transferorà all of his stock counts towards ownership. Don’t allocate the stock to the services/property.
1. A and B form New Corp
2. A contributes property v=75 b=30 for 75 shares. B contributes services v=21 and $4 for 25 shares.
3. B would have income of $21à§83: income= V of what you get – what you paid.
4. 351 would apply to A because B is now a property transferor, and they own 100%.
iv. So when testing for control don’t just add 75% plus 4%. You look at 75% plus 25%
b. TEST: IF the primary purposes of the transfer is to qualify the exchanges of the other property transferors for nonrecognition and if the property transferred is “of relatively small value” in comparison to the value of the stock already owned or to be received for services by the transferor, THEN the stock received by the service provider will not be treated as having been issues for property.
i. The value of the property transferred cannot be de minimis relative to the stock received for services
c. Revenue Procedure 77-37 – What is relatively small value
i. Property transferred will not be considered to be a relatively small value if the FMV of the property is equal to, or in excess of, 10% of the FMV of the stock already owned (or to be received for service) by the transferor.
ii. Has to be worth at least 10% of the stock that SH is receiving for his services.
iv. Solely for Stock Requirement
1. “Stock” generally means an equity investment in the company
2. “Stock” does not include stock rights or warrants
3. Nonqualified preferred stock is not “351(a) stock” and is treated as other property/boot under 351(b).
4. What is Preferred Stock? 351(g)(3)(A)à
a. Stock which is limited and preferred as to dividends and does not participate in corporate growth to any significant extent.
5. What is Nonqualified Preferred Stock? 351(g)(2)(A)
a. Nonqualified Preferred Stock is defined as preferred stock with any of the following characteristics:
i. The stockholder has the right to require the issuing Corp or a related person to redeem or purchase the stock
ii. The issuer or a related person is required to redeem or purchase the stock
iii. The issuer or a related person has the right to redeem or purchase the stock and, as of the issue date, it is more likely than not that such right will be exercised
iv. The dividend rate of such stock varies in whole or in part with reference to interest rates, commodity prices, or similar indices.
6. What is Related Persons? 351(g)(3)(B)à
a. Persons are related if they bear any of the relationships described in 267(b) or 707(b), such as family member, controlling shareholders or partners, and corporate affiliates.
7. BOOT à 351(b)
a. Receipt of Boot, notwithstanding the word solely, does not kill the application of 351. 351(b) kicks in.
b. See Treatment of Boot Section.
v. Control Requirement
1. “Control” is defined by §368(c) à 2 Part test
a. Must own 80% or more of the total combined voting power of all classes of stock entitled to vote
i. If there are multiple voting classes, combine those classes to figure out if its 80%
b. Must own 80% or more of the total number of shares of all other (nonvoting) classes of stock of the corp
vii. RULE: If a party, as part of the transaction by which the shares were acquired, has irrevocably foregone or relinquished, at that time, the legal right to determine whether to keep the shares, then ownership in such shares is lack for purposes of §351.
1. There must be no restrictions upon the freedom of action at the time he acquired the shares. Timing is immaterial.
viii. If you decide its part of a single integrated plan, you test for control after all parts of the plan are completed. Here, it’s only 50% because Shook was the only property transferor
ix. Side noteà IRS would go after Shook, he claimed 351 non recognition.
h. Revenue Ruling 2003-51 (Distinguishes between prearranged dispositions of stock that are taxable and those that are not taxable)
i. FACTS: X and Y wanted to consolidate certain businesses in a holding company structure.
1. 1st TransferàX transferred $40 of business assets to X Sub, a wholly owned subsidiary, for X Sub stock.
2. 2nd Transfer, pursuant to a preexisting agreementà X transferred its X Sub stock to Y Sub, a subsidiary of Y, for Y Sub stock
3. 3rd Transfer (at the same time as the 2nd)àY transferred $30 to Y Sub for additional stock.
4. 4th Transferà Y Sub transferred its own business assets and the $30 it got from Y to X Sub.
5. Result of all Transactions was:
a. X owned 40% of Y Sub
b. Y owned 60% of Y Sub
c. Y Sub owned 100% of X Sub
ii. ISSUE: What were the tax results of the 1st Transfer?
iii. It is consistent with the policy of 351 to treat a transfer of property that is followed by a nontaxable disposition of the stock received as a valid 351 transfer.
iv. It is inconsistent with the policy of 351 to treat a transfer of property that is followed by a prearranged sale of the stock received as a valid 351 transfer.
v. Because it could have been done another way to clearly be a 351 exchange that should make it a valid 351 exchange.
C. Shareholder’s Basis in the stock à basic provision is 358: Exchange Basis
i. 358(a)(1)à Exchange Basis: SH takes a basis in the stock received in a 351 exchange equal to the basis of the property he gave up.
ii. Installment Note: See Below for Special Basis calculation with respect to disposal of an installment note. See 435B(b).
1. Basis in the boot is the FMV of the boot.
2. Basis in the stock:
a. Start: Basis of Asset Transferred
b. Less: FMV of Boot received
c. Plus: Gain Recognized