Corporate Formations and Capital Structure Day 4

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Corporate Formations and Capital Structure(Day
4)
2
Chapter
2
Capital Structure
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Equity Capital

• Dividends paid are not deductible to the
  corporation IRC 311(a)
• Dividends received are taxable to the shareholder
  IRC 61(a)(7)
• Qualifying dividends are taxed at favorable
  capital gains tax rates IRC 1(h)

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Equity Capital

• Gains (losses) from sales of stock are generally
  capital gains (losses) to the shareholders IRC
  1221
• Gains (losses) from sales of stocks by securities
  dealers are ordinary

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Equity Capital

• Partial exclusion of gain from certain small
  business stock
• Qualified small business stock IRC 1202(c)
• For individual taxpayers, 50 of the gain is
  excluded from taxable income if the stock was
  held for more than 5 years IRC 1202(a)(1)
• Remaining gain is taxed at maximum 28 capital
  gains tax rate IRC 1(h)(3)
• 7 of excluded gain is a tax preference for AMT
  purposes IRC 57(a)(7)

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IRC 1202 - Example

• Six years ago, Violet transferred property with a
  basis of 100,000 and a FMV of 300,000 to VCorp
  (a new corporation) in exchange for 100 of VCorp
  stock. This year, she sold the stock for
  600,000.
• Violets realized gain is 500,000
• Violets recognized gain is 250,000(subject to
  a maximum 28 rate)
• Violet has a 17,500 AMT tax preference

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Equity Capital

• Losses on small business stock
• IRC 1244 stock defined IRC 1244(c)
• Up to 50,000 (100,000 MFJ) of losses from the
  sale or exchange of 1244 stockare ordinary
  losses IRC 1244(a)(b)
• Reduced limit if IRC 1244 stock was issued for
  property having basis gt FMV IRC 1244(d)
• Problems C2-51 and C2-52

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Worthless Securities

• If a security is a capital asset to the taxpayer
  and it becomes worthless during the year, it is
  treated as a capital loss on the last day of the
  tax year IRC 165(g)

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Worthless Securities

• Exception IRC 165(g)(3)
• If a corporation owns worthless securities in an
  affiliated corporation, the loss is ordinary
• Affiliated corporation must be at least 80 owned
  and
• More than 90 of gross receipts were from active
  sources for all tax years
• Problem C2-49

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Capital Structure Choice

• Debt
• Interest paid is deductible
• Interest income is ordinary income to debtholders
• Principal repayments not taxable
• Debt is boot in IRC 351
• Debt distributed is taxable
• Worthless debt is capital loss

• Equity
• Dividend paid is not deductible
• Dividend income taxed at lower rate (15) to shs
• Stock redemptions are taxable
• Stock is not boot in IRC 351
• Stock dividends are not taxable
• Worthless stock may qualify for IRC 1244
• Gains from stock sales may qualify for IRC 1202
  exclusion

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Capital Contributions

• A corporation is not taxed on contributions to
  its capital IRC 118(a)
• If a shareholder contributes property to a
  corporation
• The corporations basis in the property equals
  the shareholders basis IRC 362(a)
• Limitation for built-in losses IRC 362(e)
• The shareholders basis in existing stock
  increases Reg. 1.118-1
• Election to reduce stock basis instead of
  corporations basis for built-in losses IRC
  362(e)

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Capital Contributions Example

• Chad has owned 100 of Chad Corp. for three
  years. His basis in the stock was 100,000 at the
  beginning of the current year. During the current
  year, he contributed property to the corporation
  that had a FMV of 50,000 and a basis of 35,000.
• Chad Corp.s basis in the property is 35,000
• Chads basis in his stock is 135,000 after the
  contribution to capital

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Capital Contributions

• A corporation is not taxed on contributions to
  its capital IRC 118(a)
• If a nonshareholder contributes property to the
  corporation, its basis is zero IRC 362(c)(1)
• If a nonshareholder contributes cash to the
  corporation IRC 362(c)(1)
• the basis of property acquired within 12 months
  is reduced by the amount of the cash contribution
• any excess cash contribution reduces the basis of
  existing property
• Problem C2-47