CORPORATE TAXATION BURKE
1. INTRODUCTION TO SECTION 351
a. Policy
· The policy behind this is that it is basically a change in the form of the transferor's investment, especially in cases of sole proprietors who incorporate. Doesn't work as well with minority holders as they do not have control of what they transfer to the corporation
· Issue stock for cash- simply take the cost basis in the shares acquired
· Issue stock for other property- shareholder recognize gain/loss from difference between FMV of stock received and the adjusted basis of the property transferred to the corporation. Unless: fit under § 351(a)-(c)
b. Basic Requirements Under § 351
· For a transfer of property for stock to qualify for non-recognition of gain or loss must:
1. One or more “persons” (people, corporations, other entities) must transfer “property to the corporation;
2. Transfer of property must be solely in exchange for stock; and
3. After exchange person(or persons as a whole) must be in control of the corporation “immediately after the exchange” (80% voting and other stock)
NOTE: Corporations do not recognize gain or loss on receipt of money or other property in exchange for its stock.
c. Shareholder Basis and Holding Period
· If 351 applies then § 358(a)(1) says that the basis the shareholder takes in the stock will be the same basis in the property transferred for the stock.
· Holding Period- short term vs. long term gain/loss (one year cut-off). If the stock has the same basis as the property received, the stock will have the holding period of the property tacked on as long as it is capital asset or 1231 property(§ 1223(1)).
d. Tax Consequences of the Transferee Corporation
· If it is a § 351 transfer then the corporation will take the basis of the transferor at the time of the exchange of the property for the stock. (§§ 362 & 1032(a))
· Holding period-when stock is issued there is 0 basis in it so § 1223(2) applies, so the holding period of the property of the transferor is also transferred to the corporation with the basis.
e. Limitations on Transfer of Built-In Losses
· Property has a net built-in loss when the aggregate adjusted basis of the property exceeds the FMV.
· When transferred property to a corporation has a net built-in loss it will be given a basis of FMV immediately after the transfer to the corporation, so as to avoid tax shelters.
· Alternatively, both parties can agree to reduce the shareholder's basis in the stock received.
2. REQUIREMENTS FOR NONRECOGNITION OF GAIN OR LOSS UNDER § 351
a. “Control” Immediately After the Exchange
· §§ 351(a); 368(c)
· Control(368(c)): person or group of persons as a whole own:
1. 80% of total voting number of shares of all classes; and
2. 80% of total number of shares of all other classes of stock.
§ So that they own 80% voting and value of the corporation.
· POLICY- Continuing investment, just a change in form, is the reason that 80% control is used.
· It is required that if a group of persons are wanting control they must act in concert as a group, but need not all act at same time as long as to a plan.
· Intermountain Lumber Co. (1976) – Shook owned sawmill where Wilson processed logs. After fire destroyed it he convinced Wilson (on promise of being half holder as long as Wilson co guaranteed the loan for the new mill) and two other to incorporate to rebuild.
· Shook- new mill -> 364 shares of common stock
· One share to each of four other incorporators
· Also, concurrent agreement notified to all incorporators that Shook agreed to sell one half of his shares to Wilson (182)
Intermountain then bought all stocks from Shook and Wilson making it a subsidiary of Intermountain. Intermountain argued that Shook did not have control immediately after since he was forced to sell half his shares over time to Wilson.
HELD- that since Shook did not have full control over the stocks since he was under obligation to sell half to Wilson, he did not have requisite control and should have been taxed on the sale, not a mere change of form. Thus, the original formation should have been taxed and Intermountain should not have to take the larger gain based on lower basis.
b. Transfers of “Property” and Services
· Property- broadly construed to include cash, capital assets, inventory, accounts receivable, patents, and sometimes other intangibles.
· Not Property- return for services (351(d)(1))
· In instances where property is not exchanged for stock, like with services, that person cannot be considered as part of the control group so it may bring the other persons out of the 351 protection.
· However, if they get stock for both property and services all of their stock is counted towards the control. The property part of the exchange must not be for the purpose of qualifying others for nonrecognition and may not be “relatively small value” in comparison to stock received for services (must be > 10% of stock already owned or transferred for services.
c. “Solely” for Stock
· This means exchange for equity in the company and does not include stock rights or warrants, or other non-stock securities.
· Stock does not include “non-qualified preferred stock” which is when 1) the person has right to require corporation or related person to buy back the stock, 2) issuer or related person is required to redeem or purchase stock, 3) issuer has right to redeem and at date of transfer it is more likely than not they will, and 4) dividend varies in whole or part on interest rates, commodity rates etc. This is boot.
Treatment of Boot
1. TREATMENT OF BOOT
a. § 351(b) – if a transactio
Transferred (10)
Less: FMV of Boot Received (20 as if not electing installment method)
Plus: Gain Recognized (20)
= Basis of Stock (10)
Allocate the basis of the transferred property to the nonrecognition property first. If this basis exceeded the nonrecognition property, then would allocate to the installment.
· Only need to recognize $20 of the $90 of gain, and only over 5 years. Use § 453
· The gross profit ratio is selling price (20) – excess basis (0)= 20. Ratio is thus 20/20 or 100%.
· A will recognize no gain in year one, but with each installment 100% of it is taxable gain ($4).
§ Corporation gives $80 stock, $20 5 year note.
· Basis in property will be $10, then add more each time transferor recognizes gain on the boot.
· Assumption of Liabilities
· § 357(a)-(c)
a. That if in exchange for stock a taxpayer receives liability relief it shall not be treated as boot, and shall keep it under 351, unless:
b. (1)trying to avoid Fed income tax, or (2)not bona fide business purpose.
c. IF liabilities are in excess if basis, below.
· Assumption of liabilities counts as boot unless it is a § 351 exchange (§357(a)).
· The assumption of liabilities by a corporation in a §351 exchange is deferred by using §358(d), which reduces the basis in the stock received by treating the relieved liabilities as “money received” by the transferor for purposes of determining the shareholder's basis.
· Exceptions:
a. Tax Avoidance Exception: treated as boot if “principal purpose” is to avoid federal income taxes or not for bona fide business purpose. IF determined so, all relieved liabilities are treated as boot.
b. Technical Exception: If the sum of the liabilities assumed is greater than the aggregate adj. basis of the properties transferred by transferor, the excess is considered gain.
Ex.
A transfers $100 FMV land ($30 basis) for $45 stock and $55 mortgage assumed
Must recognize $25 gain, the excess of liabilities received over the basis, to avoid a negative basis.
· Also, if the liability would be deductible it is not taxable if assumed.
Check page 86 for example
· § 358(d)
§ For the basis of things garnered by assumption of liabilities, treat the assumed liability as money received, but only for basis.
