Sample Answers to Question 1
Corporate Tax
Spring 2016

Exam No. 4914

This transfer likely qualifies for 351 exchange treatment, meaning no gain or loss will be recognized if the shareholders meet the statutory requirements of transfer of property for stock, and are in control immediately after. You cannot elect out of a 351, so it either applies or it doesn’t. The shareholders apparently are operating as part of an integrated plan, meaning that they can aggregate their control. Together, both A and B satisfy the control test of 368(c) because they both own 100% of the total combined voting power and 100% of total shares (80% is the requirement, which they would flunk if they did this individually since they only have half each). They both transfer property, although B also transfers services as well as property. This wouldn’t be allowed on its own if B only transferred services, but according to the de minimus test, so long as the property is over 10% of the value of the shares, then it’s acceptable per Reg. 1.351-1(a). Here, B’s services are worth 90K and the cash is 60K, so the cash is over the 10% limit. B will still be taxed on the services as income, but not on the cash contributed.

The common stock received is clearly qualifying under 351, although the preferred stock is probably considered nonqualified preferred under Sec. 351(g), since it has a dividend rate that fluctuates based on interest rates. This stock will be treated as boot, but the shareholders otherwise qualify for exchange treatment because they both also received common stock. Since the stock doesn’t participate in growth, it probably qualifes as 306 stock under Reg. 1.305-5(a).

The assumption of A’s liability falls under Sec. 357, which doesn’t prevent the exchange from being a valid 351 transaction so long as there isn’t a principal purpose of tax evasion and a bona fide business purpose (none so far as we know). The assumption of liability is treated as money received, so it simply reduces the stock basis of the transferor by the amount of the liability (20K).

A’s tax consequences:

No basis on the property contributed, so she also has no basis in her stock. She may also be subject to depeciation recapture if she depreciated the asset. No tax on the common stock received per 351, but she has a liability assumption. The effect of the assumption of liability (worth 20K) would normally lower her basis by this amount. However, since she has no basis, under 357(c) she must recognize the 20K as gain. So she will pay regular income tax on the assumption of the liability, as this isn’t related to a capital asset. She could have followed the example of the Peracchi case, and contributed an IOU for 20K along with her property to artificially increase her basis, which would have prevented her from being taxed up front for the liability assumption. A must also pay tax for her boot, the nonqualified preferred stock, which has a FMV of 50K. She has no carryover basis, so she will be taxed on all of the 50K as regular income. She will receive a cost basis as a result of the taxation.

B’s tax consequences:

Under 351(d), stock issued for services does not qualify for non-recognition, so the taxes are determined under Sections 61 and 83. So, B has ordinary income tax on the personal services, which will carry over into his stock basis since the services were for stock (so he’ll have a 90K basis). He has no tax on the cash contributed or the common stock received per 351, and will get a cost basis in that amount (60K, for a total of 150K). He can potentially be taxed on the nonqualified preferred stock like A, which has an FMV of 50K, but unlike her he can simply lower his basis to 100K and not recognize any gain.

XYZ consequences:

Under 1032, the corporation has no tax consequences when it issues stock for property. It normally gets carryover basis in the contributed property. It will receive no basis from A, since she had none, but can get 20K basis from her recognized gain from the liability assumption. It also gets a basis from the cash from B and his services, but must pay SS tax, etc. on the income wages, which it can deduct as business expenses.

Exam No. 4637

As to both Amy and Ben, this is a good 351 transaction (though some gain will be recognized in the transaction): A and B transfer propety to XYZ solely in exchange for stock in XYZ, and immediately after the exchange, A and B are in control of XYZ, ie., they own over 80% of the voting power and over 80% of the number of issued shares.

Amy recognizes no gain on this 351 exchange because she transferred property and an accounts payable liability, both of which are property for 351 purposes. Her 0 basis in the land will carry over per 358. The liability would give rise to a deduction per 162 (business-related expense), and thus it’s excluded in determining the amount of liabilities assumed by XYZ, per 357(c)(3)(A), i.e., despite the fact that this liability is in excess of the basis of contributed property, she won’t recognize any gain on that excess. Also, per 358(d)(2), the liability will not reduce her basis in her stock. Thus, her basis remains at 0, and her holding period will tack per 1223, assuming she’s not a dealer in real estate (if she is though, then her holding period would not tack).

XYZ will not recognize any gain or loss from Amy’s contribution per 1032, and XYZ will take the land with a substituted basis of 0 per 362 (and the A’s holding period will tack per 1223). Because A recognized no gain on XYZ’s assumption of A’s liability, XYZ’s basis will not increase per 362(a). XYZ will take the accounts payable with a zero basis, and it will accordingly take a 162 deduction (20k ordinary deduction) when it pays them.

Ben recognizes no gain or loss upon his contribution of 60k for stock per 351, and money is property for purposes of 351 (also, even if 351 didn’t apply, he wouldn’t recognize any gain or loss precisely because there’s no gain or loss upon a cash purchase of property). His basis in his stock will be 60k per 358. He will recognize gain on the contributed services, per 351(d). Because he also contributed property, he’s still in the control group, despite contributing services, which do not qualify for nonrecognition. He’ll be taxed on the 90k worth of personal services (as ordinary income) per 83 and 61, which will also give rise to a 162 ordinary business deduction to XYZ. If B’s rights to his stock were restricted, he could’ve deferred reporting the ordinary income per 83(a) until his rights had vested; also, he could’ve made an election to immediately recognize the income per an 83(b) election.

XYZ will not recognize any gain or loss from Ben’s 60k cash contribution per 1032, and XYZ will take a face-value FMV basis in the money, or 60k, per 362. As mentioned, XYZ will take a 162 deduction upon paying B for his services.

Exam No. 4010

The first question we need to deal with is whether or not this transaction qualifies for 351 nonrecognition treatment. To meet the requirements of 351, one or more persons must transfer property to the corporation solely in exchange for stock of the corporation, and the transferors must be in control (80% test here) immediately after the exchange. The major issues for Amy and Ben are going to involve the assumption of laiblities by the corporatoin for Amy and Ben’s exchange for services.

This transaction should qualify for non-recongition treatment. First, both Amy and Ben are receiving stock in exchange for their property. The assumption of liability by Amy, though it will not be treated as boot for the purposes of calculating any recognized gain on this transaction, will not ruin the 351 transaction. The preferred stock is likely going to be treated as non-qualified becuase it flucutates annually based on the prime rate of interst charged by a commercial bank. This, however, will just be treated as boot for the purpose of the 351 transaction. It will, however, still be important to our inquiry in to whether there was control.

Both Ben and Amy are transferring property to the corporation. Ben, however, is also transferring services. These services will have seperate problems for the purposes of calculating Ben’s taxes in the 351 transaction (discussed below) but for figuring out whether Ben can be part of the control group the relevant inquiry is the ratio of property to services being submitted to the corporation. Ben must submit property worth at least 10% of the stock (calculated with reference to the FMV of the property) in order to be included in the control group. Here, Ben is providng 60k in cash (which counts as property for 351 transactions), which is 40% of the value of the stock. So, he will be considered a transferor of property for the purposes of the 351 control test.

Since both Amy and Ben own 100% of the preferred and common stock outstanding, and they only received stock + boot for the exchange, they should qualify for non-recognition treatment. The preferre stock they receive will be considered 306 stock if they sell it later.

Amy

Because of the boot included in the transaction, Amy will have to recognize some gain. Though she has realized 170k in gain on the transfer of the equipment, she will not recognize any of this. It is likely that she took depreciation and this property would be subject to 1245 ordianry income, 351 overrides this provision and preserves the recapture in the shifting of basis between the transferee and the transferor. The preferred stock to Amy is going to be treated as boot because it is nonqualified. Its total value is going to be 50,000. So, she will recognize gain on the 50,000 of the preferred stock. The assumption of laiblities are not boot if you have enough basis to cover it. But, because the basis in the transferred property is nothing in this case, she will recognize some of it.

The excess of the liaiblity over the basis is going to be treated as gain. Here, that is 50K for the preferred stock and 20K for the assumption of liabilities. That means that Amy will recognize 70k of her 170 realized gain. Her basis in her stock will be 70k. The gain from the preferred shares is going to be capital, and the gain from the amount owed to a supplier is going to be ordinary because it is likely attached to inventory (since it is with a supplier). Since the equipment she transferred is 1231 for the purposes of tacking, she can tack on the holding period to the stock she receieved in exchange for the property.

Ben

Ben will recognize ordinary income that he received (90k) for his services. He also received 50k in boot in the form of the preferred stock. however, you can’t reocgnize more than you realized. Because he put in 60k Cash in return for 150 in stock, he is only realizing 90k, all of which is going to be considered ordinary income for the purposes of calcuating tax. So, while he received boot, he won’t recognize anything on the receipt of the boot becuase he has already recognized all of his realizing income.

In computing his basis in the stock per 358(a)(1) we take the carryover basis in the property (60k in the form of cash) - boot (50k) + gain recognized by transferor (90k services) = 100k in the stock. This makes sense since Ben has essentially paid tax already on the common stock, but he has not yet paid tax on the boot. THe basis will be allocated to the stock according to their FMV, and been will recognize gain later on the boot as capital gain (per 306).

XYZ Corp.

XYZ is not going to recognize any gain or loss on the transaction. Because of the assumption of liability and the recongized gain off the preferred stock by Amy, XYZs basis in the property is going to be 70k (the property gets trasferred initially with a basis of 0 becuase it is a 1245 derpeciated property, and we add on the gain recognized to that to determine the basis). Any recognition that XYZ has on this property later will be ordinary. However, it is considered a capital asset for the purposes of tacking on the holding period.

XYZ Corp is going to get a deduction for the amount paid as compensation to Ben under 162 in the amount of ordinary income that he recognizes (90k). They will not recognize any gain or loss in this transaction. They have not recieved any other property, so there is no other basis to deal with.

Misc.

If XYZ corp was an investement corporation, 351 would be unavailable to it - but the facts here don’t suggest that it is. We don’t have any facts here to suggest that this is true. Also, given the facs here XYZ could likely elect to be an S-corporation

Created by: bojack@lclark.edu
Update:  20 May 16
Expires:  31 Aug 17