Select Page

Corporate Taxation
St. Johns University School of Law
Davidian, John E.

Corporate Income Tax Outline – Professor John Davidian Spring 2013

I. Introduction to Taxation of Business Entities

v Corporations: a business treated as a corp is treated as an entity separate and distinct for tax purposes

Ø Exception: S Corps

§ § 1361: S corp can elect to be a nontaxpaying entity only if:

· It has fewer than 100 shareholders

· The shareholders are individuals

· The shareholders are US citizens or residents

· There is only on class of stock

Ø C Corps

§ Compute a separate GI, deductions, TI and have separate tax rates

§ § 11(a): rates applicable to taxable corps are progressive (11%-35%)

· § 11(b): 2 levels of potential tax surcharges apply

¨ 5% surcharge to extent that corp has TI in excess of $100k, BUT limited to maximum additional tax of $11,750

¨ 3% surcharge corp has TI in excess of $15M, BUT limited to $100k of liability

§ §§ 11 & 1201: create no preferential level of taxation for corporations on capital gain

· § 1201: specifically creates a maximum NCG rate of 35% but only applies when regular tax rate exceeds 35%

§ § 172: permits a corp to carry back losses and use it against past income in the preceding 2 taxable years, and to the extent the income is insufficient presently or in the past the losses can be carried forward for 20 taxable years

§ § 1211: capital losses may only be deducted against capital gain

§ § 1212: unused capital losses may be carried back up to 3 years to offset previous capital gains, but can only be carried forward for 5 years

Ø Shareholders

§ Not only is the corp taxed but also the shareholders are taxed on receipt of income

§ § 1(h)(11): dividend income received by individuals is generally treated as a NCG and taxed at 15%

§ § 1201: if corp qualifies as “small business corp” when the stock was issued to shareholders who now sell stock and the selling shareholder held that stock for more than 5 years, then the selling shareholder may exclude GI of 50%

· Small business corp: $50M or less in assets at time stock is issued

· § 1(h)(4): Capital gain rate to be reported on this sale is 28%, thus only taxed on 14%

¨ Not much difference b/n 14% and 15%

Ø Check the Box Regulations

§ Reg. 1.7701-3: a domestic noncorporate business cannot be treated as a corp for tax purposes unless for some reason it elects to be treated as a corp

¨ 2 or more owners: partnership

¨ 1 owner: sole proprietorship

¨ Note: must elect to be a corporation of any kind

· Publicly Traded Partnerships: § 7704: PTPs are treated as corps for tax purposes

¨ Exception: only if 90% of GI is from passive sources

II. Corporate Formations

v Shareholder Consequences

Ø Nonrecognition

§ § 351(a): no gain or loss shall be recognized if property is transferred to a corp by 1 or more persons soley in exchange for stock in such corp and immediately after the exchange such person or persons are in control of the corp

· Elements:

1. Property transferred to corp by 1 or more persons

Ø Rev. Rul. 69-357: cash is considered property for purposes of § 351

Ø Rev. Rul. 68-55: when multiple pieces of property are contributed the shareholder will look to each asset separately not as an aggregate for gain or loss purposes

Ø § 1245 property

§ If depreciable non-real estate is disposed of by a taxpayer at a gain then the taxpayer must report that gain as OI to the extent that he has taken depreciation deductions on that property

· OI=(lesser of recomputed basis or AR)-AB

¨ Recomputed basis= AB + prior depreciation deductions

§ § 1245(a)(1): OI shall be recognized notwithstanding any other provision of this subtitle

· Exception: (b)(3): in a § 351 transaction § 1245 will only apply to the extent that the transferor of the property has to recognize gain under a § other than 1245

¨ Makes § 1245 inapplicable in § 351 transactions

Ø Installment Notes

§ § 453: applies when a T sells property at a gain and the sales price for that property is not to be received by T in the year the sale took place

· Gain=GP% * payments during the year in question

¨ GP%=GP/K Price

– GP=selling price-AB

o Selling price: the face amount of the installment obligation and any other boot that the shareholder received in the transaction, except nonrecognition property

– K Price: principal amount of the note plus any other boot received

· Reg. 1.453-1(f)(1), (3): shareholder’s basis will be allocated to the stock received in an amount up to, but not exceeding, the stock’s FMV

¨ Any remaining basis in the transferred property is used to determine the shareholder’s gross profit from the installment sale portion

¨ Payments include the boot the shareholder receives in the transaction, including cash and other recognition property; the stock is ignored

¨ Note: shareholder is treated as if he had recognized all gain in the year of the transfer

§ § 453(i): override normal installment sale reporting of boot

· In the year of an installment sale, the seller has to immediately report any of its recognized gain that represents OI depreciation recapture under § 1245

¨ Thus, if the AB had been reduced b/c of depreciation deductions and the property is § 1245 property then there is no deferral of gain; recognize all gain in year 1

§ § 453B: if a T disposes of an installment note rather than holding until payment then deferral opportunity ceases and gain or loss should be recognized

· (b): basis of installment obligation: face amount—gain from collection in full

· Reg. 1.453-9: nonrecognition is the rule b/c § 351 trumps §453B

Ø Services

§ § 351(d): services rendered to the corporation are not considered to be property

· Instead the services transferor will recognize OI to the extent of the value of the stock

¨ § 83: amount paid plus amount of GI that has to be reported in connection w/ the transfer of the stock

§ Reg. 1.351-1(a)(2)example 3: transfer of services and cash makes a transferor a property transferor to the extent of the property, but a services transferor to the extent of the value of the services

· De minimis exception: Reg. 1.351-1(a)(1)(ii): if property transferred by a taxpayer is of relatively small value in comparison to the value of the stock received for that person’s services and if the primary purpose of that property transfer was to qualify another person’s transfer under § 351 then the stock received by the service provider is not treated as issued for property

¨ Safe Harbor: Rev. Proc. 77-37: to qualify for a safe harbor the property contributed by a service provider has to be worth at least 10% of the value of the stock that the service provider is receiving for his services

2. In return for property the person receives solely stock in the corp

Ø Receipt of anything besides stock creates problems for the shareholders

Ø § 351(b): if § 351(a) would apply except for the receipt of money or other property

§ (1): shareholder has to recognize the gain to the extent of the other property or money that the taxpayer receives in the transaction

· Note: if debt securities are received then gain is deferred until the corporation actually starts pay

used in corporation’s business and held for more than 1 year

· Rev. Rul. 85-164: when the shareholder transfers a capital asset and something else then a split holding period will apply to the stock based on the relative FMV of the assets transferred

¨ Ex: if inventory (not § 1231 asset) is 2/3 of FMV transferred then 2/3 of each share will not get a tacked holding period

v Corporation’s Consequences

Ø Nonrecognition

§ § 1032: no gain or loss shall be recognized to a corp on the receipt of money or other property in exchange for stock of such corp

Ø Basis

§ § 362(a): basis will be the same as it would be in the hands of the transferor increased by the gain recognized by the transferor

· Corp takes a carryover/ transferred basis

· Reg. 1.1032-1(d): if a corporation issues stock in a § 1032 transaction and that transaction is not otherwise governed by a nonrecognition rule, the corporation will take a cost basis in the property received

· Reg. 1.453-1(f)(1), (3): gain recognized on installment notes is treated on a year by year basis

¨ The corp will increase the basis in property received when the shareholder recognizes the gain on the note

§ § 362(d)(1): in no event shall the basis of any property be increased above the FMV of such property

§ § 362(e)(2): net built-in loss

· If the corporation’s total basis in assets contributed by a shareholder would have exceeded the total value of that property then the corporation’s basis cannot exceed the total value of those assets at the time of contribution

¨ If AB>FMV then AB in hands of corp=FMV

· (e)(2)(B): the basis in property w/ a built-in loss will be reduced in proportion to the assets built-in loss immediately before transfer to the corporation

¨ The property that has a built-in loss will cause a reduction to its basis first by the amount of the aggregate built-in loss

§ Special Rules for § 1245 property

· § 1245(a)(2)(A): AB recomputed by adding all adjustments reflected on account of deductions allowed or allowable to T or to a other person for depreciation or amortization

Ø Holding Period

§ § 1223(2): carryover holding period from another taxpayer if the basis from transferor to transferee did not change

v Problem p. 79

Ø B contributed inventory w/ FMV=$20k and AB=$7k. He also contributed land w/ FMV=$10k and AB=$13k. Corporation hands out $15k of common stock and $15 cash.

§ Shareholder

· Using the asset by asset approach under Rev. Rul. 68-55 2/3 of the assets comes from the inventory and 1/3 from the land.

¨ There is $13k realized gain from inventory, but only $10k will be recognized (representing 2/3 of the cash)

¨ There is a $3k loss from land, but it will not be recognized

· AB: § 358: start w/ basis of land and inventory combined= $20k

¨ Decreased by amount of money=$15k

¨ Increased by gain recognized=$10k

¨ AB=$15k