UCF School of Accounting Tax 5015

1
UCF School of AccountingTax 5015

• Corporations
• Organization and
• Capital Structure
• Chapter Three

2
Learning Objectives

• Identify Tax Consequences of Incorporating a
  Business
• Understand special rules that apply when
  liabilities are assumed by the corporation
• Recognize basis issues for shareholder and
  corporation
• Recognize tax differences between debt and equity
  in capital structure
• Recognize tax treatment of shareholder debt and
  stock losses

3
Corporate Formation

• It is possible to achieve a tax-free corporate
  formation if the provisions of Section 351 are
  complied with.
• No gain or loss is recognized when PROPERTY is
  transferred in exchange for stock provided the
  transferors have control of the corporation
  immediately after the exchange.
• Tax attributes (holding period, deprec. methods,
  recapture potential, etc.) carry over to
  corporation if Sec 351 applies.
• Tax-free treatment is mandatory if requirements
  are met

4
Property Requirement

• Property includes money, installment
  obligations, AR, inventory, buildings, equipment,
  land, intangible assets, etc.
• Property does not include
• Services
• Indebtedness (and interest on the indebtedness)
  of the transferee not evidenced by a security

5
Control Requirement

• Those who transferred property must own at at
  least
• 80 of the total combined voting power of all
  classes of stock and
• at least 80 of the total number of shares of all
  other classes of stock
• The shares of a person who performs services and
  transfers property will be counted in the 80
  only if FMV of property is at least 10 of the
  value of the services rendered

6
Exceptions to Gain Deferral

• Boot Rule If anything other than stock is
  received by S/H, it is considered boot.
• Amount of gain recognized is the lesser of the
  FMV of boot received or the realized gain
  (receipt of boot does not trigger loss
  recognition)
• Several Assets gain/loss is computed separately
  for each property transferred. The transferor is
  assumed to have received a proportionate share
  (based on assets relative FMV) of stock/boot for
  each property transferred.
• Sec 357(a) - Assumption of transferor liabilities
  does not result in recognition of gain unless
• Tax Avoidance or no bona fide business purpose
  (all liabilities will be considered boot)
• Liabilities are in excess of basis of property
  (amount in excess of basis will be considered
  boot).
• Note that AP of cash-basis taxpayer are NOT
  included in the definition of a liability for the
  purpose of this section.

7
Basis of Property/Stock

• Shareholder
• Basis in boot property FMV
• Basis in stock Adjusted Basis of property
  transferred to corp any gain recognized by
  transferor FMV of boot property received
  money received from corp amount of any
  liabilities assumed by corp
• Corporation
• Basis of property received in Sec 351 transfer
  transferors basis gain recognized by transferor

8
Treatment of Services

• Shareholder
• Shareholder who provides services in exchange for
  shares, recognizes ordinary income equal to FMV
  of shares received
• Corporation
• value of services treated as an expense or
  capitalized, depending upon nature of the services

9
Tax Attributes of Assets Transferred in Sec 351
Exchange

• Shareholder
• Holding period of stock includes holding period
  of capital or Sec 1231 property transferred to
  corporation (if property was ordinary income
  property, holding period begins the day after
  exchange)
• Holding period of boot property begins day after
  exchange
• Corporation
• Holding period of property received includes
  shareholders holding period
• Depreciation recapture potential carries over to
  corporation

10
Avoiding Section 351

• Sale of assets to corporation allows for
• step-up in basis
• Recognize capital gain and use capital losses
• installment reporting of gain
• Sale of assets to third party
• Take back boot property
• Utilize debt exceptions to recognize gain
• Receive nonqualified stock
• Stock rights
• Nonqualified redeemable preferred stock

11
Debt in Capital Structures

• Issuance of Debt if assets are exchanged for
  debt instruments, FMV of debt received is treated
  as boot.
• When interest is paid - deductible by
  corporation. Dividends, non-deductible by
  corporation, but still taxable (now at max rate
  of 15) to recipient.
• Repayment of debt does not result in gain
  recognized by creditor. Redemption of stock can
  create ordinary and/or capital gains.

12
Contributions by Non-Shareholders

• Not considered income
• gain/loss not recognized
• adjusted basis 0
• If money is contributed
• assets purchased with money have basis of 0
• If no assets purchased within 12 months, then
  existing assets bases are reduced proportionately

13
Worthless Stock or Debt

• An investment evidenced by a security that
  becomes worthless produces a capital loss on the
  last day of the tax year.
• Securities include
• stock of a corporation
• a right to subscribe for stock to be issued
• evidence of indebtedness (bond, debenture, note
  or other evidence of indebtedness by a corp with
  interest coupons or in registered form)

14
Worthless Stock (cont.)

• Unsecured Debt Obligations if s/h lends money to
  corporation and unsecured debt becomes worthless
• If business bad debt - ordinary loss deduction
• If nonbusiness bad debt - STCL
• Ordinary Loss Situations
• Securities that are non-capital assets
• Securities of affiliated companies
• Section 1244 stock

15
Section 1244 Stock

• Qualifying small business stock
• aggregate money and other property received for
  stock is 1,000,000 or less.
• Stock must be issued for money or property
• 50 of gross receipts from active source
• Must be the original purchaser
• Ordinary loss up to 50,000 or 100,000 if
  married filing jointly (annually)

16
Section 1202 Stock

• Qualified Small Business Stock
• C Corporation whose aggregate gross assets do not
  exceed 50,000,000 on date stock issued
• Actively involved in trade or business (80 test)
• Tax Treatment of Gain on Sale
• May exclude 50 of gain (remaining 50 taxed at
  max rate of 28)
• Requirements
• Original issue shareholder
• Non-corporate shareholder
• Shares held for more than 5 years
• Max exclusion greater of
• 10 million OR
• 10 times basis of stock disposed of during the
  year