CORPORATE TAX SHNIDER SPRING 2013
I. Formation
A. §351(a) – Transfer to Corporation Controlled by Transferor (Initial Capitalization)
1. No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c) ) of the corporation.
2. Elements:
a. 1 or more persons must transfer PROPERTY to the corporation
i. Property includes: cash, capital assets, inventory, A/R, patents, intangibles (i.e. good will and industrial know-how)
¨ Stock issued for past, present, or future services ALONE does not count [§ 351(d)(1); Reg. § 1.351-1(a)(1)(i)]
à If for services, the service provider recognizes ordinary income under § 61 on the value of stock received from corp
à If more than 20% of any class of stock is issued to a service provider, the entire transaction fails control requirement
¨ BUT, if stock is given in exchange for services AND property then it CAN COUNT if the stock for services is de minimis with respect to the property
à May count ALL of the stock received for control test
b. TRANSFER
i. All substantial rights in the property must be transferred to the corporation
¨ A limited license of property does NOT satisfy
c. Solely in exchange for STOCK
i. The following are NOT stock and instead considered boot:
¨ Options & warrants
¨ Stock Rights
¨ Convertible debt securities
¨ Bonds & debentures
ii. Nonqualified Preferred Stock (NQPS) (debt-like qualities) does not count AND does not qualify towards 80% control test
¨ Stockholder can require corporation/related person to redeem/purchase stock (within 20 yrs)
¨ Issuer/related person is required to redeem/purchase stock (within 20yrs)
¨ Issuer/related person has the right to redeem/ purchase and is more likely than not to do so (within 20yrs)
¨ Dividend rate varies by interest rate/index
à No 20 yr period applies
à If there is not a real or meaningful likelihood that dividends beyond any limitation/preference will actually be paid, the possibility of such payments is disregarded in determining whether the stock is limited and preferred as to dividends [§ 351(g)(3)(A)]
d. Transferor(s) as a group must be in CONTROL of the corporation
i. 368(c) — at least 80% of total combined voting power of all classes of stock entitled to vote and at least 80% of each class of nonvoting stock
¨ TR 1.351-1: don’t have to acquire stock/control all at once, only needs to be part of an “integrated plan”
à Where the rights of the parties have been “previously defined” and the agreement proceeds with an “expedition consistent with orderly procedure”
¨ Voting Power = Power to elect BoD
ii. Reminder: NQPS doesn’t count towards 80% control test
e. IMMEDIATELY AFTER the exchange
i. Momentary control is generally not sufficient
¨ Meaning dispositions pursuant to a binding agreement or prearranged plan; a contract binding a party to sell will fail § 351
ii. Exception: binding agreement to dispose of stock in nontaxable transaction
¨ If the two transactions, viewed independently, each qualify for § 351 nonrecognition
iii. Exception: Voluntary disposition
¨ A gift after an otherwise qualified § 351 transfer will not cause the transaction to fail the control requirement
iv. Exception: Corporate Transfers
¨ The fact that a corporate transferor distributes part or all of stock that it receives to its shareholders is not taken into account [§ 351(c)]
B. Basis and Holding Period
1. Shareholder’s basis in corporation stock
a. If solely in exchange for stock, the transferor’s basis in the stock received will equal his basis in the transferred property immediately prior to the exchange [§ 358(a)(1)]
b. If more than one class of stock – aggregate basis is allocated among all class in proportion to the FMVs of each class [§ 358(b)]
2. Shareholder’s holding period in corporation stock
a. For capital or § 1231 asset – tacked to holding period of transferred property
b. For stock – begins on date of exchange
3. Corporation’s basis in transferred assets
a. Same as transferor’s basis [§ 362(a)]
4. Corporation’s holding period
a. Tacked to holding period of transferred property, regardless of capital or § 1231 asset [§ 1223]
C. Limitations on Built-in Losses
1. Net Built-in Loss – Aggregate adjusted basis exceeds the FMV of the property immediately after the transfer
2. Corp’s basis is limited to FMV immediately after the transfer [§ 362(e)(2)(A)]
3. Shareholder will get the loss
a. Unless, the S/h elects to transfer the loss to the Corp – both must jointly elect to reduce S/h basis in stock – S/h takes FMV of property in the shares [§ 362(e)(2)(C)]
4. Multiple properties transferred in same transaction with built-in gains and built-in losses
a. § 362(e)(2) basis limitation only applies when there is a net built-in loss [§ 362(e)(2)(A)(ii)]
b. Aggregate basis reduction allocated among multiple properties with built-in loss in proportion [§ 362(e)(2)(B)]
D. Impact of Boot
1. § 351(b) provides that the transferor’s realized gain is recognized to the extent of the cash and the FMV of any other boot received
a. Note: Still cannot recognize loss
b. Gain triggered by receipt of boot results in increases to the shareholder’s basis in the stock received and the corporation’s basis in the transferred property
2. Allocation of Boot – when several assets are transferred, the boot is allocated among the transferred assets in proportion to their relative FMVs
3. Calculation of New Basis for Transferor’s Stock when Boot Received [§ 358(a)(1)]
a. Basis of property transferred MINUS Boot received (cash + FMV) PLUS Gain recognized on boot
4. Example:
FMV of property is 100; basis of 10
Corp gives 80 FMV stock, 20 of boot
Calculation:
10 – 20 +20 = 10 new basis in stock for Transferor
5. Calculation of Transferee’s Basis in Property received [§ 362(a)]
a. Transferor’s basis + gain recognized by transferor
E. Assumption of Liabilities
1. Liabilities DON’T count as boot, UNLESS purpose is “tax avoidance” [§ 357(b)] in which case the liabilities count as boot, gain is recognized, and basis is stepped up as in formula above
a. Taxpayer has burden of proving absence of improper purpose [§ 357(b)(2)]
b. If tax avoidance, all the liabilities, not just the abusive debts, are treated as boot [Reg. § 1.357-1(c)]
2. Basis Stepdown Rule [§ 358(h)]
a. New Basis in Stock = Old basis MINUS Liabilities assumed
i. Note: to the extent that this is a “negative basis,” the transferor will recognize gain for that amount and take basis of ZERO in the stock
b. Example:
i. Property transferred with FMV of 550, Basis of 150, Liability of 400
¨ Stock received worth 150
ii. So. . .
¨ 150 (basis) MINUS 400 (liability) = -250 (TP will have to recognize this as a gain)
¨ Basis is ZERO in new stock received
3. Peracchi Quirk: TP gave promissory note from himself to own corp to “net out” the gain he would have had to recognize b/c the liabilities assumed exceeded basis
a. Property: Liabilities exceeded basis by 500k
b. Then gave promissory note to corp worth 1mm, claimed had basis of 1mm
c. IRS says note’s basis is ZERO b/c note is bullshit and note wasn’t being paid
d. Court says note was enforceable b/c it’s the TP stood to have an “economic loss”
i. Note was a corporate asset subject to the claims of creditors in event of bankruptcy – represented real and substantial increase in TP’s corporate investment
ii. So TP had a basis equal to face value in his own note
II. Capital Structure
A. Is it Debt or Equity?
1. Advantages of Debt
a. Deductible interest expense under 163
b. Creditors get tax-free return of principal
2. Factors: (nondispositive) from §385(b) & Shnider
a. Form of obligation
i. Must be unconditional promise to pay for specific term
ii. Remedies for default
iii. Reasonable rate of interest PAYABLE IN ALL EVENTS
iv. Avoid equity-like features; such as payment contingent on earnings or vot
E/P of 40k; midyear distribution of 15k; current yr E/P of 5k
¨ Calculation:
à First 5k of distribution goes against currnet E/P
à Remaining 10k goes against Accum E/P
à So, at year end, Accum E/P = 30k
à S/h have 15k of dividend
v. If s/h sells shares, you prorate current E/P gain or loss to the time of the distribution
¨ But, they could use all of the accum E/P against their distribution
c. Process of Analysis if current deficit/loss
i. Snap shot is at time of distribution; pro rate the loss to the time of the distribution (Ex: 5k year loss, if distr is make at 6/1, 2,500 applies)
ii. Then, Reduce accumulated E/P by pro-rated amount to determine if distribution is a dividend at that time
iii. To the extent that the distribution may exceed the newly calculated “snap shot” E/P, that excess is NOT a dividend and will reduce basis
iv. Example:
¨ Accum E/P of 40k; midyear distr of 15k; current yr loss of 5k
¨ Pro rate 5k loss back to mid year (2,500), so midyear Accum E/P is 37,500
à Subtract the 15k distribution from that
¨ Then apply last 2,500 loss at end of year
¨ End of year Accum E/P = 20k (40k -15k distr – 5k loss)
v. Example 2:
¨ Same as example 1, except distribution of 40k exceeds “midyear net accum E/P of 37,500
¨ If the distribution was 40k against the 37,500, then the first 37,500 of the distribution is a dividend, remainder is a reduction in basis
D. §311 – Distributions of Appreciated Property
1. E/P is not relevant, if corp distributes appreciated property, Corp pays the tax
a. S/h basis is FMV
b. Note: this type of transaction will create a gain, and thus E/P to the extent of the gain
E. Corporate Shareholders
1. Note: under some circumstances, dividends paid from subsidiary to parent/affiliated corporation can be tax-free (or partially) – §243
2. §1059 – Corporate shareholder’s basis in stock reduced by nontaxed portion of extraordinary dividends
a. Elements:
i. Corp s/h receives extraordinary dividend
¨ Defined as: “Exceeding the threshold percentage”
à 5% + for preferred stock
à 10% for common stock
ii. Held stock for less than 2 years
b. Aggregation of dividends
i. If multiple dividends are paid within 85 days, they will be aggregated for the purposes of this section
IV. Redemptions & Partial Liquidations (§302 redemptions)
A. When s/h sells stock back to corp, what is treatment of the redemption?
1. Sale/exchange?
2. Dividend?
B. Definition of Redemption – §317
1. Corp acquires stock from s/h
2. Regardless of whether stock is acquired, cancelled, retired, or held as tsy stock
C. If it qualifies as a Redemption, then it gets Cap Gain (sale/exchange treatment)
1. If not, it gets dividend treatment
2. Relevant for tax rate, E/P issues, and shielding with capital losses of s/h
D. 3 Ways to be treated as a redemption
1. §302(b)
a. (1) “Substantially not equivalent to a dividend”
i. This is the catchall, last ditch effort for the TP
ii. Non-voting preferred stock redemption IS essentially equiv (bad)
iii. Common stock owned by minority s/h qualifies as a good redemption – b/c of reduction in voting power, econ interest, etc.
iv. Key factor: Reduction in voting power; is it meaningful?
