FORMATION

§351 Gain/Loss No Gain or Loss recognized if:

Deferral
1. Property (not services) is transferred to Corporation by person(s)
2. Solely in Exchange for Stock of Corporation
3. Property Transferors must be in Control of Corporation, immediately after the exchange. Control means:
a. Owning at least 80% or more of voting or nonvoting stock
b. Ownership of at least 80% of the Voting Power and at least 80% of the Total Number of shares of all other classes of stock.

Exceptions Gain can be recognized when:

1. Property other than Stock is received [e.g. Cash] [aka. Boot]
2. Liability assumed by Corporation for Tax Avoidance or Nonbusiness Purpose
3. Liability assumed by Corporation > Adjusted Basis of the Property transferred

Liabilities on Assumed by  Recognize Gain on Property transfer only when Liability > NBV
Property Corporation  Gain = Liability - NBV
transfer
NBV Property Transferred
 Cash Liabilities Assumed by Corporation
= Excess Liability = Boot = Recognized Gain

Shareholder
Basis in Corp Corporate
Stock received Basis of Property transferred

Plus: FMV of Services rendered

Plus: Gain Recognized by S/H

1. Property other than Stock recv’d. [Boot]
a) Gain Recognized = Lesser of: Realized Gain or Boot received

2. Liability Assumed by Corp: [ Gain Recognition, 2 Exceptions ]

a) Tax Avoidance or No Bona Fide Business Purpose
b) Liability Assumed by Corp Exceeds Basis of Property transferred.

Minus: Boot Received

1. Cash
2. FMV of Non-Money Boot

Minus: Liability Assumed by Corporation

Plus: Gain Recognized by S/H

3. Property other than Stock recv’d. [ Cash and Non-Money Boot ]

a) Gain Recognized = Lesser of: Realized Gain or Boot received

4. Liability Assumed by Corp: [ Gain Recognition, 2 Exceptions ]

a) Tax Avoidance or No Bona Fide Business Purpose
b) Liability Assumed by Corp Exceeds Basis of Property transferred.

Minus: Boot Received

3. Cash
4. FMV of Non-Money Boot

Minus: Liability Assumed by Corp

Boot Received Boot = Property received other than corporation stock. [ Triggers Gain, Not Loss ]
 Gain Recognized by shareholder [transferor] is the Lesser of:
a) Realized Gain = [ FMV minus Basis ], of Property transferred; OR
b) FMV of Boot Received

 ** Note: Liability assumed by Corporation

o Liabilities assumed by Corporation will only trigger Gain Recognition when the Liability Amount exceeds the Adjusted Basis
the Property Transferred by the S/H.
 Liability $ amount > AB of Property Transferred.

Corporation AB of Property transferred

 Gain Recognized by S/H
Basis in = Basis of Property Corporation receives
Property
received
1. General Rule is that in a Section 351 Exchange, the Corporation takes an adjusted basis in the property from the transferor plus any ga
recognized by the transferor.

2. In order to prevent “Built-in losses” to Corporation:

 If aggregate Basis > FMV, Basis is limited to FMV

DISTRIBUTIONS   While RE (GAAP-based) presents the Net Financial Position of the shareholders of a corporation and is often used in the valuation of th
corporations common stock,
 Importance of a Corporations Earnings and Profits E&P
1.

E&P Distributions are taxed as Dividends to stockholders, to the extent of Current and Accumulated E&P.
Earning and  Distributions are deemed to come 1st from Current E&P and then 2nd from Accumulated E&P.
Profits  Any distribution in excess of both Current and Accumulated E&P is treated as Nontaxable Return of Capital that reduces the S/H’s
basis in the Stock.
 Any distributions in excess of S/H stock basis is classified as “excess distributions” and reported as capital gain distributions (taxab
income) by the S/H.
Distributions given throughout the year, example Quarterly, will need to be “ Pro-Rata”
It is sometimes necessary to allocate cash dividends paid during the year to E&P in order to determine the taxable income for each payment
When dividends are in excess of E&P, the following allocation applies:
 Current E&P :
o Current E&P are allocated on a “ Pro-Rata” basis to each distribution.
 Accumulated E&P
o Acc E&P are applied in chronological order, beginning with the earliest distribution.

Section 311(b)(1) provides that if a corporation distributes property to a shareholder, the corporation must recognize gain as if the property
were sold for its fair market value. Section 1001(a) states that the gain on the sale of property is the amount realized less the property’s
adjusted basis.

Dividend Treatment
Distributions of property reduce E&P by the greater of
1. FMV of Property
2. AB of Property minus Liabilities assumed by shareholder

STOCK Redemptions —
REDEMPTIONS
 Redemption of stock occurs when a corporation repurchases stock from a shareholder.
 Generally treated by the shareholder as a sale of the stock that will trigger recognition of gain or loss.
 However, Stock Redemption can also be structured to have same effect of a Dividend Distribution.
 Hence, the tax rules are constructed to assure that redemptions, which have the effect of a dividend, are taxed as dividends rathe
than sales of stock.

Generally a Corporation will recognize Gain or Loss on the distribution of its Property in the Complete liquidation just as if the property were
sold to the distribute for it’s FMV.

Three Circumstances that will qualify Stock Redemption to be treated as a SALE —

1. Distribution is Not Essentially Equivalent to a Dividend [ NEED ]
a. “Meaningful” reduction in the S/H’s rights, including voting rights and rights to Earnings.

2. Substantially Disproportionate redemptions will qualify as a sale if the S/H passes two tests
a. Control Test:
i. S/H must own  50% of voting shares after the Redemption.
b. Reduced Interest Test:
i. S/H must own  80% of the shares that were owned prior to the Redemption.

3. Complete Termination of the S/H’s interest in the corporation

If the requirements of Sec. 351(a) are met, no gain or loss is recognized when property is transferred to a corporation. There are three primary exceptions to Sec.
351(a). Gain can be recognized when
1. Property other than stock (e.g., cash) is received [Sec. 351(b)],
2. A liability is assumed by the corporation for tax avoidance or nonbusiness purposes [Sec. 351(b)], or
3. A liability is assumed in excess of the adjusted basis of the property transferred [Sec. 357(c)].