Corporate Taxation Outline

CORPORATE TAXATION

Prof Colombo Spring 2016

I. Corporation Formation

This class is transaction between corp and SH. §301-385

Shareholder Corp

351 1032

358 362

368(c) 362(e)

ALWAYS analyze tax consequences for both SH and Corp
Two Types

Pass-through entity: ex. Partnership, LLC, S corporations (limited to 100 SH) S corporations, which are able to “pass through” earnings directly to shareholders without the intermediate step of paying dividends.
Double-taxed corporate: Business entity is a taxpayer, own items to report, own deductions, gets taxed independently. C corporations pay income tax at the corporate rate before any profits can be paid to SHs. Then any profits that are distributed to SHs through dividends are subject to income tax again at the SH’s individual rate -> Double taxation.

Requirements for non-recognition of gain/loss under §351

§351(a): no gain/loss recognized if property is transferred to a corp by one or more persons solely in exchange for its stock if the transferor(s) of property are in “control” of the corporation “immediately after the exchange.”
§362: in aggregate, corporation’s basis is limited to FMV of the transferer. Transferred basis”: corporation’s basis in any property received in 351exchange is the same as transferor’s basis
§368(c): the term “control” means the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation.
If transferor sells his stock, such transaction is taxable (ex. Transferor sold 50% of his stock)
(1) Transferors as a group must control corp immediately after exchange – §368(c)

1) Persons(s) exchange “property” 2) “solely” for stock 3) control “immediately after”

§368(c) is ownership of stock:

At least 80% of the total voting power of all classes of stock entitled to vote (combined voting power) and
Ex. Class A (100 shares – 2 votes) Class B (100 shares – 1 vote): so at least 240 votes are required to control
At least 80% of total # of each nonvoting stock

Basically transferor group must own at least 80% of each nonvoting class

As a group

In deciding whether there is “control” (80+80%), we consider a group of transferors, instead of the individual SH
Such transferors act in concert under a single integrated plan
No limit on # of transferors
Timing: integrated plan means transfers need not be simultaneous; sufficient if rights of parties are “previously defined” and an “expedition consistent with orderly procedure” Reg. §1.351-1(a)(1)
Transfers must be mutually interdependent steps in formation and carrying on of the business

Transferred separately in 30 min. and can be a separate plan
Transferred separately several years later and can be an integrated plan

Immediately after the exchange

Step transaction doctrine – Intermountain Lumber

S owned a sawmill and S and W jointly owned a separate plant to process lumber. The sawmill was burned down and W, along with S, personally co-guarantee a $200K loan to replace it with a larger facility in exchange for 50% of S’s stock. Two and two other incorporated S&W, S transferred his sawmill to S&W in exchange for 364 shares of common stock and S&W issues one share to each four. W got 182 shares of S’s stock for $500 per share to be paid in installments. 3 years later, Intermountain Lumber acquired all the outstanding S&W stock.
Issue: Transfer of assets to S&W was tax-free under 351?

If 351 applies, Intermountain must depreciate the assets of S&W on consolidated returns on incorporators’ basis (362); bc stock purchase agreement merely gave W an option to purchase shares, and S was in control of corp.
If 351 does not apply, transfer of assets to S&W was sale and Intermountain could base depreciation on returns on FMV at time of incorporation, which was higher than incorporators’ cost; bc agreement for sale required S to sell almost half of S&W share outstanding to W over a period of time, thus depriving S of 80% of stock required for control of S&W immediately after exchange

Holding: It was a sale bc S relinquished legal rights to determine whether to keep shares at the time of acquisition of stock. S was obliged to transfer the stock as S receives W’s principal payments and did not own the requisite % of stock immediately after exchange. W is not a person who transfers property in exchange for stock so not part of control group. Only S is part of control group.
The moment after S incorporate S&W, he owns 100% stock but agrees to transfer 50% of stock to W.
1) W is not a transferor of property, since he did not transfer any property to S&W except cash 2) W cannot be counted for control under 351 3) ownership depends on obligations and freedom of action of transferee (S) regarding stock. If transferee has irrevocably foregone or relinquished legal right to determine whether to keep the shares, no ownership. Vs. if no restriction upon freedom of action at the time of stock acquisition, it is immaterial how soon the transferee disposes of his stock or whether such disposition is in accord with a prearranged non-binding plan

Binding agreements to dispose of stock in taxable transactions

May cause the deal to fail if more than 20% is disposed, control is lost and not qualify 351
Momentary control is not sufficient if the holdings of the transferor group fall below 80% as result of dispositions of stock in taxable transactions pursuant to binding agreement or prearranged plan
the sale is an independent decision by a SH, not a part of a plan, it probably won’t break control.

Binding agreements to dispose of stock in non-taxable transactions

Not cause the deal to fail
A voluntary disposition of stock does not break control even if original transferor of property falls below 80% immediately after exchange

A voluntary donative disposition of stock – gifts, donations

Generally treated as independent of the plan
NOT cause the deal to fail but subject to timing
If gift is transferred before some group members transfer their property to NewCo, then control might be lost.

(2) Transferors of Property and Services – Reg § 1.351-1(a)(1),(2)

“Property”: generally, cash (for 351 purpose), capital assets, inventory, accounts receivable, patents, intangible assets (eg. nonexclusive licenses and industrial know-how), not service
: stock issue