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Corporate Taxation
Temple University School of Law
Abreu, Alice G.

CORPORATE TAXATION
ABREU – SPRING 2005
 
I.            INTRODUCTION
A.    Theories of Corporate Tax Law
1.      Tax income earned at the corporate level two times
2.      Interfere as little as possible with corporate transactions
B.     Regular Corporate Income Tax
1.      Two Levels of Tax
i.        Corporate level – tax income when its earned by the corporation
ii.      Shareholder level – tax income distributed to SH’s as dividends or in liquidation
2.      C-Corporation: corporations which do not make an election under subchapter S (majority of corps)
3.      S-Corp: corporation making election under subchapter S – pass through entities that are treated like partnerships
4.      Rate Structure: § 11
i.        Dividend treatment – §1(h)(11)
a.       Dividends are ordinary income but taxed at capital gains rates (can’t use to offset capital losses but you get the preferential rate of tax – max rate is 15%)
5.      Determining Corporate Tax
i.        Similar to taxing individuals, but no itemized deductions b/c premise under §162(a) and §165(a) deductions is that all corps are engaged in trade or business
ii.      Dividends Received Deduction – §243 – for inter-corporate dividends
iii.    §1212(a) → capital losses allowed only to extent of capital gains with a 5 year carryover
iv.    §1032 → corporation does not realize income upon the issuance or sale of its own shares for money, property or services
C.     Corporate AMT
1.      Doesn’t apply to S-Corps or small business corps
2.      §55(a) provides for AMT
i.        Corporation generally required to pay greater of regular tax or AMT
D.    What is a Corporation?
1.      Treas Reg §301.77-(b): any business organized as a corporation under state or federal law is automatically a corporation for federal income tax purposes
2.      An entity classified as a partnership can elect to be taxes as a corporation – election required, otherwise default classification is partnership
3.      §7701(a)(2) – defines partnership
4.      §7701(a)(3) – defines corporation
5.      Check the Box Regulations
i.        Federal tax treatment doesn’t affect entity’s identity or obligations under local law
ii.      Any business entity not required to be treated as a corporation for federal tax purposes (a.k.a. eligible entity) can choose its classification under Rules of Reg. §301.7701-3
a.       If you’re incorporated or publicly traded you’re a corporation for federal tax purposes
b.      Otherwise you can elect your classification (default is partnerhip)
c.       LLC classification is taxpayer choice under check the box regs
§         Disregarded Entity: LLC with one owner, despite the status of the owner
 
II.            FORMATION OF THE CORPORATION
A.    §351: permits incorporation without recognizing gain and prevents the recognition of loss (policy: tax law should be neutral toward corporate transactions)
1.      transfer of property to corporation must be exchanged solely for stock and the transferor must own 80% of the stock immediately after the transfer → §351(a)
2.      §351(b) Boot Provision → if other property is transferred in addition to stock, gain is recognized to recipient to extent of amount of cash received plus fair market value of property received
i.        loss is not recognized to recipient
B.     Basis With Regard to Incorporation
1.      §358 (shareholder’s basis)→ basis of stock received in exchange for property under §351 is equal to transferor’s basis in property
2.      §358(d) → liabilities are treated as money for basis purposes (transferor’s basis decreased for stock received in the exchange)
i.        However the assignment of liabilities is not boot and will not take a transaction out of §351 (unless tax avoidance purpose or liabilities assumed exceed basis of property transferred)
3.      §362(a)(1) (corporation’s basis) → basis of transferred property in the hands of the transferee corporation equals the basis in the hand of the transferor (carry over basis)
i.        §1032 – corporation does not recognize gain or loss on receipt of money or property in exchange for its own stock
C.     Summary
1.      Incorporation for the Individual (transferor)
i.        Non recognition → §351 (gain to extent of boot)
ii.      Basis → §358
2.      Incorporation for the Corporation (transferee)
i.        Non recognition → §1032
ii.      Basis → §362 (increased by any gain realized by SH as a result of boot)
D.    Effect of Boot
1.      Cash Boot
i.        Corporate Level: carry over basis from transferor plus gain recognized by the transferor
ii.      SH Level: gain to extent of boot, basis in stock remains unchanged
2.      Property Boot
i.        SH Level: run transaction through §358
ii.      Corporate Level: §362 carry over basis plus gain of the SH (what they get from SH plus the cost to get it)
3.      Encumbered Property Boot
i.        §357 excludes this boot from income (SH not totally discharged b/c liable via ownership in corporation – essentially the same economic pocketbook)
ii.      SH’s basis in stock received – §358(d)
a.       Basis of property exchanged minus amount of discharged liability
§         Discharge is treated as money only for purpose of §358
E.     Assumption of Liabilities
1.      §357 subject to 2 exceptions
i.        §357(b) → transferred for tax avoidance or if no bona fide business purpose for transferring liabilities
ii.      §357(c) → amount of liabilities assumed exceeds basis of the property transferred
2.      Peracchi v. Commissioner (1998 9th Cir.) – p. 90
i.        FACTS: Peracchi was the sole SH, liabilities of transferred property exceeded basis so Peracchi included a note for $1M
ii.      ISSUE: what is SH’s basis in the note?
iii.    HOLDING: SH gets the face value of the note
a.       §357 treatment applies b/c the note is non illusory – sole SH and in a good economic position to make good on the note
b.      Basis to corp is carry over → §362(a)
iv.    NOTE: IRS has not acquiesced to this case so following it could be dicey
3.      Rev. Ruling 95-74 – p. 99
i.        FACTS: P transfers assets of Manufacturing Business (manufacturing plant and contaminated land) to new corp. S in exchange for S stock and S’s assumption of manufacturing plant liabilities (including those associated with contaminated land)
ii.      ISSUE 1: are liabilities assumed by S under purview of §357(c)(1) and §358(d)?
iii.    HOLDING 1: liabilities aren’t included in 357(c)(1) b/c it’s a liability the payment of which would give rise to a deduction (§357(c)(3)(A) → S simply steps into the shoes of P and there is no debt rel

o keep purpose of provision in mind
ii.      Treating transfer of property that is followed by a non taxable disposition of the stock received as a transfer described in 351 is not necessarily inconsistent with the purposes of 351
a.       Control requirement may be satisfied even though stock received is transferred pursuant to binding agreement in place during first transfer
G.    Receipt of Stock for Services
1.      §351(d)(1) → stock issued for services shall not be considered as stock issued in return for property
i.        SH received stock in exchange for services realizes ordinary income equal to the FMV of the stock
ii.      At corporate level 2 options
a.       Services that are not capital in nature → corp. can deduct the FMV of the stock (§83(h))
b.      Services that are capital in nature → corp. will capitalize the value of the stock
iii.    Transferring both property and services for stock → must bifurcate the transaction
a.       §351 treatment for property, §83 treatment for services
2.      Effect of Stock for Service on other Transferors
i.        §351 not defeated as to other parties unless transferor of services receives more than 20% of stock (b/c transferors would be in control of corp.)
ii.      Transferor of service and property receives more than 20%
a.       Qualifies as transferor of property and stock received for services and stock received for property is counted regarding the control determination
b.      Caveat: property may not constitute a relatively small value →if it does, services stock is not counted to test control
§         Rev. Proc 76-22: must have value equal to at least 10% of stock received for services
3.      Property vs. Service Flavored Assets
i.        Property = secret processes or formula whether patentable or not
a.       Rev. Ruling 64-56 (p. 121) → if transferred info equals property then services performed ancillary to and subsidiary to property will not take transfer out of §351
b.      Rev. Ruling 71-564 (p. 121) → trade secrets equal property
§         Corp. must receive exclusive right
c.       Rev. Ruling 70-45 (p. 121) → business goodwill equals property
4.      Corporate Level
i.        Stock in exchange for services to corporation whether during incorporation or after gets non recognition at corporate level pursuant to §1032
 
III.            DIVIDEND DISTRIBUTIONS
A.    Corporation Established – getting profits to SH’s
1.      Salary
i.        SH receives ordinary income, corporation takes deduction
2.      Dividend
i.        SH receives ordinary income but is taxed at capital gains rate (§1(h)(11))
ii.      Corporation gets no deduction