12-1 contributions to corporations in exchange for stock section 351 no gain/loss recognized on...
TRANSCRIPT
12-1
Contributions to Corporations in Exchange for Stock
Section 351 No gain/loss recognized on transfers of
property to corporation in exchange solely for stock if immediately after transaction the transferors are in controlProperty does not include servicesSolely generally means only common stock
is received (no ‘boot’)Control means ownership of 80% of voting
power and value of all classes of outstanding stock
12-2
Impact of Boot on Section 351 Exchange
Boot includes cash or other property received by shareholder as part of Section 351 exchange Recipients of boot recognize gain (but
not loss) equal to the lesser of the gain realized or the FMV of the boot received
Tax basis of boot equals its FMV
12-3
Tax Basis and Section 351 Exchanges
Shareholders basis in stock received equals: Adjusted tax basis of assets transferred Less FMV of boot received Plus gain recognized
Corporations basis in assets received equals: Adjusted basis to contributing
shareholder Plus gain recognized by contributing
shareholder on exchange
12-4
Corporate Tax Consequencesof Receipt of Contributed Property
No gain or loss recognized by corporation on receipt of property in exchange for its stockNo gain recognized by corporation on receipt of property contributed by nonshareholder Example: contribution of land by municipality
to encourage business development Zero tax basis to corporation in such property If contribution is cash, tax basis of property
purchased with the cash is reduced
12-5
Corporate Capital Structure – Debt versus Equity
From issuing corporation’s perspective, debt is tax advantaged relative to equity Interest payments are deductible Dividend payments are not
From investor’s perspective Interest and dividend receipts are
taxable as ordinary income (Post-2003 Act, dividends taxed at 15%)
Sales of appreciated securities produce capital gains/losses
12-6
Debt versus Equity – Clientele Effects
Who are the natural clientele investors for corporate shares paying dividends? Other corporate investors – DRD
Who are the natural clientele investors for corporate shares that do not pay dividends? Individual investors – lower capital gains
rates
How will the before-tax rate of return on debt (which is tax-disfavored for the investor) compare to the before-tax rate of return on stock?
12-7
Corporate Distributions
Dividend: distribution by a corporation to its shareholders to the extent made out of earnings and profits (E&P) Taxed to shareholders as ordinary income
Distributions in excess of E&P are first considered a return of capital, reducing shareholder tax basisDistributions exceeding E&P and shareholder tax basis are taxed as capital gains
12-8
Earnings & Profits
Concept: measure of a corporation’s ability to pay its shareholders a return on their investmentEnding E&P equals Beginning E&P Plus current E&P Minus current deficit E&P Minus dividend distributions out of E&P
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E&P continued
Annual calculation of current E&P: Current taxable income Less federal income tax and other
expenses not deducted in calculating taxable income but that reduce dividend-paying ability
Plus items of income not included in taxable income but that increase dividend-paying ability
E&P is general assumed to be earned ratably throughout the year
12-10
Distribution Ordering Rules
If current E&P is positive Distributions are treated as dividends to
the extent of current E&P Distributions in excess of current E&P
are dividends to the extent of beginning accumulated E&P
If current E&P is negative, subtract from beginning accumulated E&P Distributions are dividends to extent
above sum is positive
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Dividends-Received Deduction
DRD available only to corporate shareholders receiving qualified dividends (generally from taxable domestic corporations)Amount of DRD depends on ownership share If ownership <20%, DRD = 70% If ownership >20%, <80%, DRD = 80% If ownership > 80%, DRD = 100%
12-12
Corporate Distributions of Non-cash Property
Shareholder recognizes dividend income equal to FMV of property received, and takes a tax basis equal to FMV Distributions of appreciated property
Corporation recognizes gain equal to excess of FMV over tax basis of property
FMV of distributed property reduces E&P Distributions of depreciated property
Corporation cannot recognize loss on excess of property’s tax basis over FMV
Adjusted basis of distributed property reduces E&P
12-13
Stock Dividends
Non-taxable stock dividends Proportionate distribution with no potential
for differential impact on any owner’s share of outstanding stock
No dividend income recognized, no impact on corporate E&P
Taxable stock dividends Disproportionate distribution of stock Dividend income recognized equal to FMV of
stock received, corporate E&P reduced by FMV
12-14
Stock Redemptions
Some possible motivations for redeeming stock: Stock needed for ESOP contributions Stock needed for option plans Belief that stock is under-valued,
management attempting to signal this belief to the market
Possibly more favorable tax treatment to redeeming shareholders than achieved if corporation simply pays a dividend
12-15
Example: After-Tax Cash Flow from Dividends
Tony owns 10% of the stock of X Corporation and receives a dividend of $10,000 If Tony’s marginal tax rate on dividend
income is 15%, calculate the tax due on his dividend income, and his after-tax cash flow
How would your answer change if the shareholder were Tony Inc. a corporation with a 35% marginal tax rate?
12-16
Example: Sale of Stock
Tony sells stock for $10,000. The stock was purchased two years ago for $2,000. Calculate Tony’s tax liability and after-tax
cash flow from the stock sale. How would your answer change if the
shareholder were Tony Inc.? On an after-tax cash flow basis, would Tony
(Tony Inc.) prefer a dividend or stock sale? What important economic difference between
these transactions affects this comparison?
12-17
Example: Dividend versus Sale Extended
Suppose that Tony owns 100% of the stock of X Corporation. If Tony sells 10% of his stock to an
unrelated third party, has his economic interest in the corporation changed substantively?
If X Corporation redeems 10% of Tony’s stock, has his economic interest in the corporation changed substantively? Is this transaction economically different
from a dividend?
12-18
Stock Redemptions: Dividend versus Sale Treatment
Qualifying redemptions are treated as a sale of stock. Otherwise, amounts received in redemption are taxed as dividends. Qualifying stock redemptions:
Distributions not essentially equivalent to a dividend
Substantially disproportionate distributions Distributions in complete termination of a
shareholder’s interest
12-19
Types of Stock Redemptions
Distributions ‘not essentially equivalent’ to a dividend Subjective determination, requires a
‘meaningful reduction’ in shareholder’s interest Decrease in voting control important factor to courts
Substantially disproportionate distributions after redemption, shareholder must own less
than 80% of interest owned prior to redemption after redemption shareholder must own < 50%
of combined voting power of the corporation
Redemptions in complete liquidation of shareholder’s interest
12-20
Shareholder Tax Consequences of Redemptions
If redemption qualifies in one of the above categories: Treated as sale of stock for tax
purposes Loss realized on redemption not deductible
if shareholder owns, directly or indirectly, 50% or more of the stock of the corporation prior to the redemption
12-21
Tax Consequences to Redeeming Corporation
If redemption funded with cash, no gain or loss recognized by redeeming corporationIf redemption funded with property other than cash Gain recognized if property’s FMV >
adjusted tax basis Loss not recognized if FMV < adjusted
tax basis
Redemption also reduces E&P
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Example: Redemption versus Dividend
At the beginning of the year, Lance owned 1,000 shares Camelot Corporation with a total tax basis of $20,000. The corporation had 2,500 shares outstanding. If the corporation redeems 500 of Lance’s
shares for $100,000, is the redemption treated as a sale or as a dividend, and what are the resulting tax consequences?
What if the corporation had 1,500 shares outstanding prior to the redemption?
12-23
Corporate Liquidations
Tax consequences depend on ownership: Liquidation of controlled subsidiary into
parent corporation Liquidation of corporation not
considered a controlled subsidiary
General rule: tax treatment of liquidations maintains the double taxation inherent in the corporate tax system
12-24
Liquidations continued
Liquidation of corporation not a controlled sub Tax consequences to corporation:
Treated as if all assets sold on date of liquidation General rule: resulting gains and losses
included in taxable income for final tax return Tax consequences to shareholders:
Treated as sale of stock, with FMV of liquidating distribution as amount realized
Tax basis of assets received = FMV
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Liquidation of Controlled Sub
Parent recognizes no gain or loss on receipt of property in liquidation of controlled sub Carryover basis in property received
Subsidiary recognizes no gain or loss on distributions of property to controlling parentIf sub < 100% owned, distributions to minority owners treated like non-liquidating redemptions Sub recognizes gain (not loss) on property
distributed Shareholders taxed on sale of shares