1.Section 351 applies only to the formation of new corporations. Select one: True False 2.At the formation of Corporation D the following transactions occur: A transfers land to a D Corporation in return for 500 shares and the corporations asssumption of $100,000 debt. The land had an adjusted basis of $360,000 and a fair market value of $600,000. B also receives 500 shares based on transfering $200,000 cash and as consideration for agreeing to perform services for the corporation. Which of the following statements are true. Select one: Section 351 applies causing no recognition of income by either A or B Section 351 applies causing A to report $100,000 of gain based on the receipt of $100,000 boot. Section 351 does not apply because the 80% control test is not met. Section 351 applies causing A to recognize no gain , but B will recognize $300,000 of compensation income. None of the above 3.Section 351 does not apply to the issuance of stock solely for services. Select one: True False 4.At the formation of Corporation D the following transactions occur: A transfers land to D Corporation in return for 500 shares and the corporation's asssumption of $100,000 debt. The land had an adjusted basis of $360,000 and a fair market value of $600,000. B also receives 500 shares based on transfering $200,000 cash and as consideration for agreeing to perform services for the corporation. Which of the following statements are true. Select one: D corporation can claim a deduction of $300,000 based on the issuance of shares to B for services A's adjusted basis in the stock acquired is $260,000 The corporation's adjusted basis in the land is $360,000. All of the above a. and b. are correct 5.Gain from Section 1244 stock is treated as ordinary income. Select one: True False 6.To determine the adjusted basis in the stock acquired in a Section 351 transfer you should consult Section Select one: 357 362 358 None of the above 7.By issuing debt to taxpayers who are also their shareholders a corporation has created a way to reduce double taxation as to both the principal and interest payments. Select one: True False 8.A owns 1000 shares of F Corporation. It is proposed that an additional 1001 shares will be issued to C in return for land worth $100,000 ( adjusted basis $20,000) and $100 cash. At the same time one share will be issued to A for $100. Which of the following statements are true ? Select one: Section 351 applies because A and B transferred property for stock and controlled the corporation after the transfer. The corporation's adjusted basis in the land is $20,000 C's adjusted basis in the stock is $20,100 All of the above None of the above 9.When corporations issue shares as compensation for services performed, the corporation will deduct the amount reported as income by the employee. Select one: True False 10.At the formation of Corporation D the following transactions occur: A transfers land to a D Corporation in return for 500 shares and the corporations asssumption of $100,000 debt. The land had an adjusted basis of $60,000 and a fair market value of $600,000. B also receives 500 shares based on transfering $500,000 cash 10.Which of the following statements are true. Select one: B's adjusted basis in the stock is $500,000 A must recognize $40,000 gain All of the above None of the above

Session 7 - Corporate Organization and Capital Structure Objectives Understand the application of IRC Section 351 Understand the tax considerations of using debt or equity in the capital structure of a corporation Understand the purposes of: Section 165(g) Section 1244 Lesson STOCK TRANSFERS The transfer of stock by a corporation to an individual or organization can result in income or loss to the taxpayer receiving the stock. For example, if an individual receives stock in return for performing services for a corporation, the service performing taxpayer will usually recognize income based on performing services (note special rule of Section 83 for restricted stock). If a taxpayer transfers property for stock, the usual result is recognized gain or loss. Subchapter C contains very important exceptions to this general rule. One such special rule is Internal Revenue Code Section 351 which can result in no current recognized gain or loss on property transferred to a corporation in return for stock. To accomplish this non-recognition result, certain requirements must be met (see discussion below. It is also important to note that the non-recognized gain is deferred by means of special rules applicable to determining the adjusted basis of the stock of the corporation. The details of this rule are discussed below. Section 351 Qualification If the requirements of Section 351 can be satisfied, gain or loss related to a transfer of property can be deferred. Section 351 applies to transfers of property to a corporation by one or more persons who receive stock of the corporation and immediately after the transfer control the corporation. This is sometimes described as the following three requirements: 1. 2. 3. transfer of property to a corporation the property transferors must receive stock of the corporation immediately after the transfer the transferors (as a group) must control the corporation. Transfer of property to a corporation Section 351 only applies to property transfers. If stock is issued for services, Section 351 does not operate to prevent recognition of the compensation income. Property is broadly defined and includes cash. The property transferors must receive stock of the corporation To be covered by section 351, a transferor of property must receive stock of the corporation to which the property is transferred. It is possible to receive something other than stock (\"boot\") and still qualify for Section 351 treatment. As discussed below, the receipt of boot can cause gain to be recognized. Immediately after the transfer the transferors (as a group) must control the corporation. Immediately after the transfer the group of taxpayers transferring property for corporate stock must control the corporation. For this purpose, control means 80% or more of the stock outstanding after the transfers (IRC Section 368(c)). Note that the control test focuses on total ownership by taxpayers transferring property regardless of when or how they acquired the stock. This aspect of the control test makes it possible for previously existing corporations to be the subject of a qualified Section 351 transfers if existing shareholders participate in the transaction. It is also possible that a taxpayer who transfers both property and services for stock can be part of a group that satisfies the control test. To prevent manipulation of the control test the Regulations at 1.351-1(a) provide that \"relatively small\" property transfers by a pre-existing shareholder or a service provider will not be treated as a property transferor. The result will be a smaller group to meet the control test. Remember if someone transfers property and services and Section 351 applies, only the gain or loss under Section 351 is deferred. Stock transferred for services will result in gross income to the recipient of the stock. Section 351 only applies to transfers of property. Results of Application of Section 351 If Section 351 applies it is possible that no gain or loss will be recognized by the transferring shareholder. However, the shareholder's basis in the stock acquired and the corporation's basis in the asset acquired will reflect the postponed gain related to the property transferred. For Example: If A forms a new corporation by transferring land (FMV = $100; AB = $10) for all of the stock, Section 351 will apply causing A to recognize no gain. A's adjusted basis in the stock is $10(IRC Section 358). The corporation's adjusted basis in the land is $10 (IRC Section 362). Note that the deferred gain related to the land ($90) is reflected in both A's adjusted basis in the stock (FMV = 100 - AB= $10 = $90) and the corporation's adjusted basis The Receipt of Consideration Other Than Stock IRC Section 351 states that no gain or loss is recognized if property is transferred \"solely in exchange for stock\" with the control test being met. This language seems to imply that if a transferor receives something other than stock (\"boot\"), Section 351 does not apply. This is not a correct conclusion. If a property transferor receives boot and stock. They can be covered by IRC Section 351 but they must recognize gain to the extent of the boot received (IRC Section 351(b)). The boot rules will never operate to cause recognition of gain greater than the realized gain. Boot does not cause loss to be recognized. The basis of the stock acquired (IRC Section 358) and the asset acquired by the corporation (IRC Section 362 is adjusted appropriately for the boot received and gain recognized. Assumption of Liabilities - Boot? It is possible that as part of a Section 351 transfer, the corporation will assume a transferor's liability. In rules described by IRC Section 357 and 358, the liabilities assumed will usually not be treated as boot for purposes of recognizing gain, but will be treated as boot for purposes of calculating adjusted basis. There are exceptions to this statement which are described in Section 357. Please review IRC Section 357, 358 and 362 (see Doc Sharing). This complication will be a portion of the Research Problem # 1 which will be your Session 4 responsibility. Tax Consequences of Corporation Issuing Its Stock A corporation does not recognize gain or loss when its stock is issued. This result also applies to capital contributions by shareholders and non-shareholders. When a corporation issues its shares as compensation for services causing the employee to report income, the corporation may be entitled to a deduction for compensation for services performed. CORPORATE CAPITAL STRUCTURE Capital Contributions Corporations recognize neither gain nor loss on the receipt of money or other property in exchange for its capital stock (including treasury stock). a. Contribution to corporate capital by a shareholder (not in exchange for stock). (1) (2) Corporation generally has a basis in the property equal to the shareholder's basis. However, the basis adjustment for loss property also applies to contributions to capital. (3) b. No income is recognized by the corporation. Shareholder recognizes no gain or loss on the transfer and the basis in the original shares must be adjusted accordingly. Contribution by nonshareholders. (1) Corporation recognizes no income and the basis in the property transferred to the corporation is zero. (2) If money is contributed by a nonshareholder, the basis of property acquired is reduced by the amount of money contributed. Special rules apply if the money contributed exceeds the cost of the property acquired. Debt Versus Equity The use of stock or debt as a source of capital for a corporation can have significant tax consequences. The most obvious difference between using equity (stock) or debt is that interest is deductible and dividends are not. Effectively, using debt in the capital structure is a way to avoid possible double taxation. A second possible advantage of debt is that the repayment of the amount invested (amount originally borrowed) is usually not taxable to the investor (lender) If stock is redeemed there is likely to be income reported by the shareholder. These differences create a tax incentive for use of debt. As discussed in the text there is a risk that the overuse of debt in the capital structure could cause IRS to recharacterize the debt as stock. This \"thin capitalization\" risk is important to remember to prevent the unexpected very unfavorable result of unintentional double taxation. Nontax factors usually determine the maximum debt possible for a given corporation. INVESTOR LOSSES If stocks or bonds are worthless the remaining adjusted basis can be deducted (IRC 165(g)). Section 1244 allows ordinary loss treatment of limited amounts of losses related to the sale of \"section 1244 stock\". The concept of section 1244 stock that was acquired from the corporation when the corporation was \"small\". The details of Section 1244 are discussed in the text. This treatment is normally not an advantageous result for the investor. Section 165(g)(1) usually leads to a long-term capital loss. No deduction for the loss will be allowed unless the investor can prove that the stock is entirely worthless. Ordinary (rather than capital) loss treatment on stocks and bonds is permitted in the following circumstances: When the shareholder is a dealer in securities. When the affiliated corporation rules of 165(g)(3) apply. When 1244 applies as to stock in a small business corporation. For individual investors, a loss incurred on the sale or worthlessness of a stock investment results in capital loss treatment. For these taxpayers, the deduction for net capital losses is limited to a $3,000 per year offset to ordinary income. In contrast, qualifying investors who meet the requirements of 1244 may deduct a loss of as much as $100,000 per year. Further, a loss from the sale or disposition of 1244 stock is accorded ordinary rather than capital treatment. There has been discussion to increase the $3,000 loss limitation to provide greater tax incentives for small investors. Given that some individuals' portfolios may reflect significant stock market losses, such a change would prove highly popular among investors. In addition, it would bring the tax treatment of ordinary investors' losses more in line with that of 1244. Furthermore, the $3,000 limitation is not indexed for inflation. This threshold has not changed since the 1970s. Nonetheless, any efforts to enact such a change face a significant roadblock. Opponents point out that a more generous loss limitation would reduce revenue at a time when the Federal budget deficit is projected to continue at high levels. Hence, the need for fiscal discipline precludes any change that would further aggravate the deficit