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Corporate Taxation
University of North Carolina School of Law
Bryan, Patricia L.

Bryan – Corporate Tax – Spring 2013

Formation of a corporation

Review

1) Review

a. When sell prop, AR – B = G

b. When depr prop, adjust B (to get AB)

c. Treat diff recourse and NR liab

d. Characterization of G and L—1031 prop

e. Review prob 10—depr recapture

2) Why would a busi ever incorp (b/c, remember, corps other than S corps are subject to double tax)

a. Stock easily transferable, so IPO may be easier

b. B/c there is possibility of a future tax-free reorg (takeover)

i. For stock you get in exchange, you keep the B—defer G

c. If corp had older ee’s w/ higher salaries, b/c you’re escaping dbl tax anyway

i. And if these ee’s have appreciated stock, when they die they can pass on stock and takers get stepped-up Bàescape G recog all together

(A) Introduction to section 351

*351a, c, d1-2; 358a, b1; 362a, e; 368c; 1032a; 1223(1), 2; 1245b3

*1.351-1a, b; 1.358-1a, -2b2; 1.362-1a; 1.1032-1a, d

1) Policy of sec 351

a. 351aàno G or L recog if prop trans to corp by person(s) solely in exchange for its stock if transferor(s) of prop are in “control” of corp “immediately after the exchange”

b. 351 applies to bother transfers to new corp and preexisting corp

c. Policy of 351: transfer of appreciated or depreciated prop to corp controlled by transferor viewed as mere change in form of SH’s investment (no change in substance)

i. Policy more difficult to defend in case of minority SH

ii. W/out 351 there would be disincentive to incorp, b/c may have to recog G that would otherwise not be recog yet

2) Basic requirements

a. 3 major requirements:

i. One or more persons must transfer “property” to corp

ii. Solely in exchange for stock of corp

1. (this req loosened in 351b—doesn’t have to be solely, but only complete nonrecog if it is solely)

iii. Transferor (or transferors as group) must be in “control” of corp “immediately after the exchange”

b. “Control”—368c:

i. “ownership of stock possessing at least 80% of total combined voting power of all classes of stock entitled to vote, AND

ii. at least 80% of total number of shares of all other classes of stock”

3) SH B and HP

a. Policy: prevent total forgiveness of unrecog G or forfeiture of any unrecog L—just a deferral

b. 358aàcarryover BàB of stock (“nonrecog prop”) received in 351 exchange shall be same as B of prop transferred by SH to corp

c. 1223(1)àHolding periodà

i. IF transferred prop is capital asset or 1231 assetàtacked HP

ii. OtherwiseàHP begins on date of exchange

4) Tax consequences to transferee corp

a. 1032aànonrecog for corpàcorp shall not recog G/L on exchange of money or other prop for its stock (including treasury stock)

i. Corp steps into shoes of transferor

b. Corp’s Bà362aàcarryover Bàcorp takes transferor’s B

i. Preserves G or L inherent in asset for later recog by corp

ii. Double GàG will eventually be recog by corp and SH…

1. Constitutional issueàDouble tax on pre-incorp Gàcan we tax corp on G that accrued before corp obtained asset? Is this really “income” to corp? SCOTA said yesàthis the price/cost of deferral to SH

2. If SH doesn’t like this, then can just sell prop for cash then buy stock

a. But then no deferral of G

c. Corp HPà takes SH’s HP

i. 1223(2)àif prop that has transferred (ie carryover) B to corp, transferor’s HP likewise will also carry over

d. Valuation question… take following facts for example:

i. Prop A: 25 cash

ii. Prop B: 25 equip (FMV=25), B=5

iii. Corp could take 25 cash and buy 25 equip and have a B in equip=25

iv. Whereas if corp takes equip (prop B) w/ B=5 from transferor in 351 exchange, corp will have less value to depr or more G upon sale of equip later

v. Difference in B that corp will take from these two properties should make the cash more valuable than the equip worth 25 fmv (lower B in equip causes this)

vi. B/c of this difference, the 25 cash should be worth more (present value) than 25 equip here

vii. (note: this not the same thing in subchapters S and K (pships and pass through entities)—same issue does NOT arise)

5) Limitations on transfer of built-in Ls (inherent lossàAB>FMV)

a. Corp’s aggregate AB limited to FMV of transferred prop (362e2)

i. FMV immediately after transfer

ii. Limitation applied on transferor-by-transferor basis (1.362-4b2)

b. Built-in-L where aggregate AB > fmv

i. Any G recog by SH that increases corp’s B is taken into acct in determining whether prop has net L in corp’s hands (1.362-4b4(ii). Ex. 6)

c. Multiple propsàOnly when net built-in-Làmultiple prop transferred in same trans, some w/ G and some w/ L, rule only applies when net L

d. Allocate B reduction

i. If more than one prop w/ L, B reduction allocated among props in proportion to their respective built-in-Ls immediately before trans (362e2b; 1.362-4b1)

e. AlternativeàSH/corp electionà362e2C—SH and corp may jointly elect to have:

i. Reduce SH’s B in stock it receives to fmv of prop

ii. Then corp takes SH’s old B, preserving the L for corp

iii. 1.362-4c3àB reduction here must not be more than B reduction would have been if election had not been made (ie, must not be more than corp’s B reduction)

iv. *Election only for L—cannot elect to opt out of 351 for G purposes…

(B) Requirements for Nonrecognition

“Control” immediately after the exchange

*351a; 368c

*1.351-1a1

1) “Control”à368cà

a. Ownership of at least 80% of total combined voting power of all classes of stock entitled to vote, AND

b. At least 80% of total number of shares of all other classes of stock

2) Note: does NOT say that transferor has to acquire control; merely that transferor must be in control after trans

a. Eg, 80% owner (A) and 20% owner (B). A contributes one dollar for one more share (1%). A now 81% owner. B is now 19% owner. A in control immediately after, so it qualifies for nonrecog under 351

b. But note this diff for bringing someone else into control group

3) Control groupàwho is in it?

a. Can bring another into control group by having him trans small amt of prop

b. BUT transferred prop must be MORE than relatively small value—ie, more than 10% of stock already owned by him

i. This clearly an accommodation trans, but as long as that prop stays w/in corp (ie, isn’t immed

nsferors for nonrecog AND

2. IF stock issued to nominal transferor is of “relatively small value” in comparison to value of stock already owned or to be received for services

ii. Rev. Procedure 77-37—NOT relatively small value IF fmv of prop transferred = or > 10% of fmv of stock already owned (OR to be received for services) by transferor

Solely for “stock”

*Skim 351g

1) “Stock” generally means an equity investment in the co

a. Does NOT include stock rights or warrants (1.351-1a1, last sent)

2) “Nonqualified preferred stock” (NQPS)àtreated as “other prop” (ie boot)ànot stock for purposes of 351

a. NQPS definition (351g2B) =

i. Preferred stock (PS)

1. PS = stock which is limited and preferred as to div and does NOT participate in corp growth to any significant extent (351g3A)

a. Stock NOT treated as participating in corp growth to any significant extent UNLESS there is real and meaningful likelihood of SH actually participating in corp’s earnings and growth

b. IF NOT real and meaningful likelihood that div beyond any particular limitation or preference will actually be paid, the possibility of such pmts disregarded in determining whether stock is limited and preferred as to div

ii. With ANY of the following characteristicsà

1. SH has right to right to require corp or a “related person” to redeem purchase of stock

a. Persons “related” if they bear any of the relationships described in 267b or 707b, such as family members, controlling SHs or partners, corp affiliate, etc (351g3B)

2. Issuer or related person required to redeem or purchase the stock

3. Issuer or related person has right to redeem or purchase the stock,

a. AND, as of issue date, it’s more likely than not that such right will be exercised

4. Div rate on such stock varies in whole or in part with ref to interest rates, commodity prices, or similar indices (351g2A)

5. *First 3 apply ONLY IF à

a. Right or obligation w/ respect to redemption or purchase may be exercised w/in 20-yr pd beginning w/ issue date of stock, AND

b. Such right or obligation NOT subject to contingency which, as of issue date, makes remote the likelihood of the redemption or purchase

b. Treated as stock for all other purposes (other than 351) until treasury provides otherwise (see legislative history)

c. Effect of 351gàtreats debt-like preferred stock as boot, resulting in potential recog of G (but generally NOT L) to recipient under 351b

i. Allowed to recog L IF ONLY nonqualified preferred stock (no other type of stock) received in exchange (351g1B)