Chapter 4: "Corporations: Organization and Capital Structure

Read all pages for Learning Objectives 1 through 3 and read the Sec! 3"1 #aterial in L!O! $
Organization of and Transfers to Controlled Corporations
Shareholder transfers of propert% to a corporation in e&change for stoc' of the corporation (ill
either be a recognition or nonrecognition event! )f certain conditions are #et *3"1 dictates
nonrecognition treat#ent! *3"1 can appl% at incorporation and also (hen transfers are #ade to
e&isting corporations!
Reasons for nonrecognition treat#ent:
+asic result of nonrecognition treat#ent: substitute and carr%over basis
,&a#ple: - incorporates her business b% transferring assets (ith -+ . 4//// and 012
. 3"/// to 4 Corporation in e&change for all of the stoc' of 4!
Result if there is recognition treat#ent:
5ouble ta& nature of C Corporation under Sec! 3"1:
• 6(o levels of gain are created!
• 6(o levels of loss (ould be created but additional rules result in just one loss being
preserved! See notes on -+ of -ssets for Corporation!
24, 25
Section 3"17a8 9eneral rule
:o gain or loss shall be recognized if propert% is transferred to a corporation b% one or #ore
persons solel% in e&change for stoc' ;and i##ediatel% after the e&change such person7s8 are in
control of the corporation!
6hree i#portant ele#ents: propert% is transferred< solel% in e&change for stoc'<
transferor7s8 in control after transfer 7at least =/>8
Solel% turns out not reall% to #ean solel% because boot can be part of the transaction!
Section 3"1 can still appl%!
?ropert% is broadl% defined and includes tangible and intangible assets!
Stoc' includes co##on stoc' and #ost preferred stoc'! Stoc' rights are not included!
Corporate debt that is transferred to a shareholder is boot!
Control 7*33=7c88:
)##ediatel% after the e&change transferors o(n stoc' (ith at least =/> of 718 the total
co#bined voting po(er and 7@8 the total nu#ber of all other shares!
27, Handout #1
?ropert% issues:
Services do not constitute propert%! Ao(ever if a person contributes both propert% and services
and the value of the propert% eBuals at least 1/> of the value of the services the person can
count all the stoc' in the o(nershipCcontrol test! Other(ise none of the stoc' is counted!
• Dith respect to services the treat#ent b% the corporation (ill be to report an i##ediate
e&pense or to capitalize and then a#ortize!
• 6he service provider recognizes ordinar% inco#e . 012 of stoc' received for the
services! -+ of stoc' received for services . 012 services provided!
32, 33, 31, 11 HW 9, 35
Control issues:
• ")##ediatel% after" does not reBuire si#ultaneous transfer but transfers at different
dates should be close in date and in accordance (ith an agree#ent or plan!
• 1o#entar% control is not sufficient if there is a disposition of stoc' that is part of an
agree#ent or plan! 1o#entar% control is probabl% sufficient if there is not a plan!
Handout #2
HW 3, , 10, 1, 2!, 29, 41, 42
)f assets other than stoc' are transferred to the shareholder realized gain is recognized to the
e&tent of boot! Losses are not affected! +oot . cash E 012 of nonFstoc' propert% received!
+oot affects the stoc' basis calculation! 6he basis of the boot . 012!
Calculation of +asis of Stoc' for Shareholder
Shareholder stoc' basis 7*3"=8 .
-+ of propert% transferred to corporation 7GsubstituteH8
1inus 012 of boot received andCor liabilities relieved of
?lus gain recognized
. -+ of Stoc'
Calculation of -+ of -ssets to Corporation
9eneral rule:
-+ of propert% transferred 7Gcarr%overH8
E ?lus an% gain recognized b% shareholder
. -+ of ?ropert%
,&ception to carr%over basis 7applied on a shareholder b% shareholder basis8:
)f the su# of the -+ of assets I su# of the 012 of assets 7Gbuilt inH loss8 the corporation (ill
use the su# of the 012 for its -+ in assets received! 6o deter#ine -+ for each asset the
overall reduction fro# -+ to 012 is done prorata based on relative a#ounts of built in losses!
,lection available: the reduction can be done for shareholder stoc' basis instead
Handout #3, 39 HW 2, 5
-ssu#ption of Shareholder Liabilities b% the Corporation
*3"$7a8 general rule: shareholder relief fro# liabilities is not boot! 7)n other settings being
relieved of liabilities is boot8! Liabilit% relief affects the stoc' basis calculation 7see above8!
6(o e&ceptions to nonFboot treat#ent 7if both appl% follo( rule of *3"$7b88:
1! *3"$7b8: )f the principal purpose of the liabilit% transfer b% the shareholder is to avoid ta&
or if there is no bona fide business purpose for the liabilit% assu#ption then the entire
a#ount of liabilities transferred is treated as boot!
@! *3"$7c8: )f the su# of the J012 ofK liabilities transferred b% the shareholder is greater
than the su# of the adjusted bases of the properties transferred then the e&cess a#ount is
a ta&able gain! 76he stoc' basis (ill turn out to be zero!8
• Dhen #easuring liabilities for this test ignore liabilities that (ould have been
deductible b% the transferorCshareholder if the liabilities had been paid before the
transfer 7e!g! -ccounts ?a%able of cash basis ta&pa%er8!
!, 13, 40, 2 "#o$pre%ensi&e', 3! HW 12, 14, 15, 3
Aolding periods for stoc' and propert%
Shareholder holding period for stoc':
• "6ac' on" (ith respect to capital and *1@31 assets transferred
• da% of transfer (ith respect to ordinar% inco#e assets
Corporation holding period for propert%:
• "6ac' on"
5epreciation recapture
)n a *3"1 transaction recapture potential re#ains (ith an asset that is transferred to the
43 HW 17