CORPORATE TAX, ABREU, FALL 2012
When does a Corporation Have Taxable Income?
I. Elementary Transactions
A. Any contribution to capital: not included in gross income: §118
1. This applies to SH contributors & non SH contributors Reg. 1-118
2. Add’l pymts by SHs: also not incl in gross income: Reg. 1-118
B. Corp X gives SH stock in xchg for contrib to capital: nonrecog under §1032
1. This is still a realization event for Corp X (it’s a sale or disposition of stock): §1001
a. Further wrinkle: if the corp is selling treasury stock (instead of newly issued stock), where the corp bought back its own stock & put it in its treasury. The basis will be the amt corp paid for its own stock. If the corp bought back stock for $100 and sold it for $125, that's a gain. If we assume that the increase in value will be or was taxed, it will be taxed at the corporate level. We don't distinguish, for tax purposes, between newly issued stock and treasury stock in this instance.
2. Basis for the ppty rcvd by Corp: same as basis in the transferor’s hands (carryover basis: §362)
3. Basis for the ppty rcvd by SH: §358, see section below
4. NB: special rules for ppty rcvd in incorporation: see section on §351 below
C. Corp X sells stock (not its own stock) to (unrelated) Corp B for $: cap G/L to X.
1. Capital asset (§1221): any asset as long as it not excluded from definition of capital gain, such as:
a. Stock in trade: inventory à ordinary assets
b. Depreciable asset à ordinary assets
c. Most other assets à capital assets
2. Corps don't get a preferential rate on capital gains anymore, but capital gains are pref to ordinary income if corp has capital loss. Can only deduct capital losses if they have capital gain.
II. Income from Discharge of Indebtedness
A. If a corp buys back its debt instruments for less than its face value or issuing price, the excess (difference) b/t the price paid (buyback price) and face value/issuing price is includable in gross income. Same result if corp's sub or related entity does the buyback. (Kirby Lumber CB 6)
1. If the debt is SH debt that the SH forgives, it's the same as contribution to capital
2. § 108(e)(6) only applies to what the SH paid in the debt instrument (the principal, not the interest)
3. EX: Corp X issues a bond (face value $10). Buys back that bond for $7. X has gain, includable in gross income, of $3.
4. Applies if Corp X does the same thing through its sub or related entity: 108(e)(4)
5. Applies if Corp X acquires the bonds @ lower price through a 3d party: CB 8, N. 4 (Rev. rul. 91-47 CB 8)
6. Applies if Corp X issues stock in exchange for debt: 108(e)(8)
III. Income from Sale of Stock vs. Ordinary Dividend
A. A pre-sale distribution of unwanted assets to its SHs will usually be an ordinary dividend under 301, NOT part of the consideration for the subsequent stock sale. TSN Liquidating CB 10
1. Therefore, if the SH rcv’g div = corp, the corp SH can deduct the div (Dividends Received Deduction, or DRD, §243)
2. Exception: if it really looks like a Waterman Steamship sham “conduit rationale”. Compare:
a. Gilmore: Buyer doesn't want particular assets of Target (cash on hand & US bonds), so Target distributes unwanted assets (cash on hand & US bonds) to T's SHs before selling T stock to B. This presale distribution = taxable dividend, NOT part of the stock sale b/t B & T.
b. Coffey: Presale distribution of unwanted, hard-to-value assets = dividend, NOT consideration for stock sold. Buyer & Seller can't agree on valuation, so stock purchase K incl provision that unwanted assets will be distributed to SHs before the sale. Sellers want cap gains treatment, so they argue the distribution is part of the stock sale NOT a dividend. Sellers lose.
c. Rosenbloom: Presale distribution of unwanted assets to sole corp SH = ordinary dividend, NOT amt distrib in partial liquidation. Presale distribution provision incl in K for sale.
d. TSN: Though the form gives a good tax result, the form should be respected when it has a good business reason for doing so: the assets were really unwanted (unlike Waterman)
e. BUT, the subsequent transaction (recapitalization) makes it look like Waterman
i. Different kinds of assets distinguishes TSN from Waterman
ii. Also, the cash in Waterman steamship eventually ends up with the seller. The cash recapitalized in CLIC stayed with CLIC, it didn't reach TSN
3. NB: TSN transaction is a “bootstrap acquisition”: the target company pulls itself by its own bootstraps by using its own assets to constitute the purchase price (see General Geophysical, Zenz below)
4. This rule applies to pre-sale cash dist to indiv SHs too, but indiv SHs wd prefer “consideration for sale of stock” treatment à cap G/L. NOT div treatment. See Casner & Rev. Rul. 75-493, CB 19, n. 1
IV. GU & Gain or Loss on the Disposition of Property
A. Lifetime (nonliquidating) distributions: §311
1. Gain (§311(b)), not loss (§311(a)), is generally recognized to the distributing corp.
2. Current §311 = repeal of General Utilities doctrine (repealed 1986). GU:
a. Held: SHs’ sale of assets (appreciated while in Corp’s possession), which were distributed to SHs by Corp not in complete liquidation, will not be attributed to the Corp and trigger realization of gain or loss
b. Was widely understood to stand for the proposition that: Corp X realized no G/L on the dist of appreciated or depreciated ppty to its SHs (CB 24.6)
3. Policy behind GU repeal and current law:
a. Discourage tax avoidance / fraud by not recognizing loss
b. Because Corp controls when to sell / dispose of property, i.e. the realization event, Corp could cherry pick when / what kind of gains to have.
c. Similar to rationale behind not allowing indiv TPs to deduct capital losses unless they have a significant offsetting capital gain (§267 (a)(1))
4. Under GU facts and current law: Practical advice to corp:
a. Don't distribute this property to SHs: Loss won't be recognized at the corp level
b. Instead, sell the asset to another pty. 311 doesn't apply, and corp can recognize the loss.
B. Liquidating Distributions: §§331/336; 332/337
NB: Complete liquidation, so DRD (§243) won’t apply!!
1. Regular complete liquidations (no parent/sub context): §§331/336
a. SH level: amounts received [FMV of ppty] in complete liquidation (not partial) are treated as full payment in exchange for the stock: §331
i. SH gets 1) basis offset and 2) will either realize a capital gain or loss (difference between basis and FMV at the time of the liquidation).
ii. Distribution in liquidation of encumbered property
(A) SH's gain = (FMV of property received) – (SH's basis in stock liquidated) – (liabilities assumed).
(B) SH's basis in the property = FMV value without adjustment to reflect assumed liability.
(C) b/c SH must pay liabilities they are viewed as a cost of acquiring the property and thus are properly reflected in basis.
b. Liquidating (i.e. distributing) Corp level C will recognize G or L just as if the property had been sold to the SH for its FMV (basis in asset – FMV of asset):
i. E.g, Corp. basis in assets = $100, FMV of corporate stock at time of liquidation = $400, corporation recognizes gain in amount of $300.
ii. For ordinary assets (like inventory) ordinary income treatment
iii. For capital assets – capital treatment (gain/loss)
iv. For losses, NB ANTI-STUFFING RULE (§336(d)): C can’t recog full amt of loss on ppty that lost value before you got it.
(A) Calculation: Corp’s new 336d A/B = B @ time of transfer – (B in Transferor’s hands – FMV @ time of transfer)
(B) Corp’s Recog Loss = (Corp’s new 336d A/B) – (FMV @ time of 336 disposition)
v. Disqualified property: property to which §351 applies within 5 years (so you can stuff the corporation but you have to be patient, wait at least 5 years before liquidating).
vi. Distributions Involving Liabilities add CB 31 prob 2
(A) §336(b) provides that the AR on the sale shall deduct liabilities in property assumed by SH, even if it exceeds FMV.
c. NB: In a 331/336 situation there's no parallel similar to 334.
i. 331 “treated as full payment in exchange for stock” =
(A) exchange = capital gain or loss provision is triggered. This is a characterization.
(B) payment = cost = basis
(C) This is unlike 332 (involving Parent & Subsidiary), b/c 332 is a nonrecognition provision. Therefore we don't know what the basis should be, so we need a provision for basis. 334 fills that gap.
2. Complete liquidations of subsidiary by parent corp: §§332(S)/337(P)
NB: Liq of a S is effectively a merger of S into P. So 332 liq // nonrecog provisions in tax-free reorgs
i. Is it a 332 liquidation? This def of liquidation ONLY applies to 332.
Outside Basis: P’s basis in S’s stock.
Inside Basis: S’s basis in S’s own assets.
Disappearing Basis Problem:
· P liquidates S.
· Stock of S disappears & P directly owns S’s assets.
· P’s basis in S stock disappears.
· Also a prob in 302 / 318.
P (corp rcv’g the dist) MUST own least 80% ownership of vote and 80% of value of S [§332(b)(1): stock ownership rqmt] § Bright line rule; 80 is the magic number. §1504(a)(2). Then you will be treated proportionately.
§ Non participating, nonconvertible, nonvoting preferred stock doesn’t count in determining control. §1540(a)(4).
§ P could “flunk” this rqmt on purpose thru bona fide sale of some of its shs of S before liquidation, to get out of 332
(B) The dist (by S) MUST be in complete cancel’tn / redemp’tn of all its stock
(C) The S must transfer all its ppty either:
§ w/in the taxable year [§332(b)(2)] OR
§ w/in a series of dist, according to a plan of liq which dist all ppty w/in 3 yrs
essive compensation §162(m): compensation has to be reasonable to be deductible. Excessive compensation can be a prob in CHCs
c. 162(k): redemption expenses are not really biz expenses.
3. NB: Constructive Dividends (fr Taxations to SH section) ≠ Reasonable Biz Exp: CB 127
a. Pymt by a corp, tho not directly made to the SH, may satify an oblig of SH or confer a personal benefit if TP fails to show that corp is primary beneficiary of the pymt à Constructive dividend.
i. EX: Corp pays legal fees in criminal tax evasion case of its sole SH.
(A) Constructive div to SH
(B) ≠ deductible biz exp of Corp (“unreasonable expense”)
B. Distinguishing between Equity and Debt: Standard, not a Rule
4. Fin Hay: the equity/debt distinction is very murky. Look to:
Equity (high risk, high reward for SH)
Fin Hay majority: this is equity
Debt (low risk, low reward for SH)
Fin Hay dissent: this is debt
*both SHs holdings of debt & equity are exactly proportional. Economically, Fin Hay situation = Hypo 2. Both situations: SH is at the end of the line for risk, but at the front of the line for reward
SHs followed the form! This is usually the reason TPs lose in debt equity cases (they don’t follow the form). “nail in the coffin of the TP”
· Not following form will hurt the TP
· But this is a dissent, so following form isn’t sufficient.
Arm's length transaction (purely biz transaction): form matters more than CHC transactions
Market practice: this is how real estate businesses work.
This undercuts majority opinion’s arg that this isn’t arm’s length
*Corp used $ to buy the initial assets of the corporation: very risky
Corp paid dividends!
Demand loan (shows that it’s not arm’s length transaction)
Demand character (loan on demand): not important b/c SH could still demand
*Long term of the debt:
Market interest rate
Taxation to the Shareholder
I. Dividends: Rule, not a Standard
A. Definition of Dividends: MUST HAVE 1) distribution of property AND 2) E&P
1. Defined in the statute, §301 à 316
a. “distribution of property as defined in § 317”
b. § 317(a): property means money, securities, and any other property, except corp's own stock
i. Fin Hay distributing MSFT stock = property
ii. Fin Hay distributing Fin Hay stock ≠ ppty
2. Distribution must be to SH in SH capacity (not to SH in a creditor capacity)
a. § 301: if distribution to SH in SH capacity isn't a dividend for tax purposes, it is a return of capital — § 301(c)(2)
i. If SH basis is 100 & corp distributes non-dividend of $1000, $900 is taxable gain (as return of capital) to the SH — § 301(c)(3)
ii. $900 is capital gain to SH
3. § 316: any distribution out of E&P if there ever was any E&P = dividend
a. Won't know until the end of the year until you know if a distribution on Jan 1 is a dividend.
b. For tax purposes, this trumps any state corp laws.
c. E&P isn't defined in the statute, but gives some idea where the line is
i. 312: Effect on E&P
ii. E&P begins w/ taxable income AND incl other non-taxable income (Bangor CB, codified at § 312(l))
iii. Policy: corps have accessions to wealth that are not taxable for policy reasons
(A) ENP is trying to count all economic profit, not income in the tax sense. The distinction the statutory scheme is trying to draw, in defining a dividend as a dist out of ENP is capital investment in the corp VS actual profit (dividend)
(B) Practical problem: we can't make corps track every dollar as $ is fungible, but we need the distinction. Therefore we have a rule to reach the right result mostly, but we can't draw the distinction in fact. This rule provides certainty.
iv. see also 312(k), special rules for depreciation & ENP
v. Advantages to no statutory definition: TPs can follow form but take advantage. Policy is clear
4. Unlike debt / equity that has an unwieldy standard, dividend is a rule