Business Enterprise Tax
Professor Tierney / Barrett – Fall 2011
Corporate Income Tax
Marginal tax rate schedules for corporations – tops out at 35%
Definition of gross income
Corporations don’t have “personal” expenses, no personal or dependency exemptions, and no standard deductions. No difference between above-the-line and below-line deducts.
Corporate parents are able to deduct dividends paid by other corporations, to avoid triple+ taxation consequences
70% deduction for payments of dividends by unrelated corporations, and 100% deduction if payment from subsidiary to parent
Capital losses to corporations are allowable only to the extent of capital gains
But more generous carryforward and carryback provisions (see IRC 1211, 1212)
Taxable year and accounting method
Most C corps have flexibility re: tax year. § 441.
Generally, C cops are required to use the accrual method of accounting. § 448(a).
§ 267: forced match accounting: simply, accrued liability of the corporation cannot be deducted by the corporation until it is actually paid out to the shareholder (to equalize tax consequences)
§ 482: Treasury has the power to allocate income among related business entities to prevent tax evasion or clearly reflect income of entities
Can also consolidate the returns of related entities to rationalize their economics
Rules for S/H
Rules for Corp
Holding Period Rules
§ 351: nonrecognition provision for contributing property for stock of corporation
§ 351(a): no gain or loss shall be recognized if:
Property is transferred to a corp.
By one or more persons
In exchange for stock in such corp and
Immediately after the exchange such person or persons are in control (as defined in § 368(c)) of the corp
§ 351(a) applies to new and preexisting corps if all elements are satisfied
Policy of § 351: similar to other nonrecognition provisions
Mere change in form of same investment
Facilitate corporate formation
Sidney contributes land with an AB of 30 and FMV of 100 for 100 worth of stock in the corporation she fully controls
Sidney has a nonrecognized gain of 70 (tax deferred)
Shareholder Basis in § 351 transactions: § 358(a)
Nonrecognition requires preservation of tax attributes.
§ 358(a)(1): basis of stock received in a § 351 exchange shall be the same as the basis of the property transferred by the shareholder to the corporation.
FMV of boot (cash and property) and
The amount of loss to the taxpayer which was recognized on such exchange, and
Amount which was treated as a dividend, and
Amount of gain which was recognized on such exchange.
Shareholder Holding Period in § 351 transactions: § 1223(1)
§ 1223(1): where a transferor receives property with an “Exchange basis,” such as § 351 exchange, the holding period of that property is determined by including the period during which he held the transferred property if the transferred property is a capital asset or § 1231 asset; if it’s not, the transferor’s holding period begins on the date of the exchange.
Thus, transferred equipment and capital assets will result in a tacked holding period for contributor’s stock.
Transferred inventory and accounts receivable will not result in a tacked holding period, but will start anew for contributor’s stock.
§ 1231 detour
There are capital assets.
There are § 1231-assets: depreciable assets used in business [such as a tractor used on a farm (i.e. equipment)] There are things that are non-capital asset and non-§ 1231-assets (such as inventory and accounts receivable)
Under § 1231, those assets (if held for a year) have a net gain then there is long term capital gain; if there is a net loss the loss is an ordinary loss.
Tax Consequences to Transferee Corporation:
§ 1032(a): nonrecognition of gain/loss at corporate level
provides that a corp shall not recognize gain or loss on the receipt of money or other property in exchange for its stock (including treasury stock).
§ 362(a): basis rule for corp
In connection w/ § 351 transaction, corp’s basis in acquired property shall be the same as it would be in the hands of the transferor, increased in the amount of gain recognized to the transferor on such transfer.
§ 362(e)—limitations on built-in losses
If there would be a net built-in loss in property taken by a corporation in a § 351 transaction, the basis in such property shall be its FMV immediately after such transaction.
Parsing § 351
§ 368(c) defines “control” as:
(1) the ownership of at least 80% of the total combined voting power of all classes of stock entitled to vote, and
(2) at least 80% of the total number of shares of all other classes of stock.
Control must be obtained by one or more transferors of “property” who act in concert under a single integrated plan; transfers need not be simultaneous.
A majority shareholder cannot usually join a minority shareholder in transferring de minimis property under 351 in order for the minority shareholder to get nonrecognition treatment
Regulations provide that the stock will not be treated as having been issued for property if the primary purpose of the transfer is to qualify the exchanges of the other property transferors for nonrecognition and if the stock issue to the nominal transferor is “of relatively small value…”
Revenue Proc 77-37: property transferred “will not be considered to be of relatively small value … if the FMV of the property transferred is equal to, or in excess of, 10% of the FMV of the stock already owned (or to be received for services) … by [the transferor].”
“Immediately After the Exchange”
Momentary control will not suffice if the holdings of the transferor group fall below the required 80% as a result of dispositions of stock in a taxable transaction pursuant to a binding agreement or a prearranged plan. But a voluntary disposition of stock, particularly in a donative setting, should not break control even if the original transferor of property parts with the shares moments after the incorporation exchange.
Intermountain Lumber Co. v. Commissioner
Issue: was transfer of assets to S & W tax free under § 351, requiring S & W to take a transferred basis in the assets under § 362?
Taxpayer: Intermountain Lumber argued that incorporation did not qualify unde
ss to such recipient shall be recognized.
Basis effect: § 358(a)(1)(B)(ii)—when gain is recognized due to presence of boot in a § 351 transaction, shareholder may increase his basis in the stock equal to the gain realized in the transfer.
Basis is also decreased by the amount of fair market value of the boot (FMV of property and cash) received. § 358(a)(1)(A)(i)-(ii).
Corporate Level Effect
§ 362(a): corporation’s basis in property acquired in a § 351 transaction is the same as it would be in the hands of the transferor, increased by the amount of gain recognized by the transferor in such transfer.
Revenue Ruling 68-55:
Issue: correct method of determining the amount and character of the gain to be recognized by a Corp under § 351(b) under various circumstances…
General rule 1: each asset transferred must be considered to have been separately exchanged.
No netting of gains and losses for purposes of applying §§ 367 and 356(c).
If there are losses, they cannot be recognized (§ 351(b)(2)), and cannot be used to offset gain realized on the exchange of other assets.
Assumption of Liabilities
§ 357(a): except as provided in (b) and (c), if—(1) the taxpayer receives property which would be permitted to be received under § 351 or 361 without the recognition of gain if it were the sole consideration, and (2) as part of the consideration, another party to the exchange assumes a liability of the taxpayer, then such assumption shall not be treated as money or other property, and shall not prevent the exchange from being within the provision of § 351 or 361 as the case may be.
Assumption of liabilities ≠ boot for § 351 (recognizing gain or loss) /361.
§ 358(d) – Basis for assumption of liabilities
Where a corp. in an exchange assumes a liability of the taxpayer, the assumption of the liability will be treated as money received by the taxpayer on the exchange
In conjunction with § 358(a)(1)(A)(ii), any assumption of liabilities reduces the basis in the stock exchanged as if it were money (with no corresponding adjustment upwards)
Two exceptions of 357:
§ 357(b): totality of the circumstances review that prevents tax avoidance
If this is found, then all liabilities are treated as boot (punitive aspect).
§ 357(c): prevents negative basis
If the sum of the amount of liabilities assumed, exceeds the total of the adjusted basis of the property transferred pursuant to such exchange, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of property which is not a capital asset, as the case may be.
If this applies, basis in stock going forward will always be $0.