3. corporations- organization & capital structure
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3. Corporations—Organization & Capital Structure
L. Bravenec
(rights reserved)
10 July 2001
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3.1. Organization: S/H’s Acquiring or Increasing an Interest
• Transfers of Property to a Corporation in Exchange for its Stock and/or other property
• This is a Taxable Event, so . . . .
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3.1: Organization S/H’s Acquiring or Increasing an Interest
• The Context--Property Transactions– Step 1. Taxable event
– Step 2. Gain/loss realized (Asset by asset)
– Step 3A. Gain/loss recognized (Asset by asset) 3B. Exchanged basis in replacement
property
– Step 4. Gain/loss character (Asset by asset)
– Step 5. Gain exclusions/inclusions and loss disallowances/allowances
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Full Recognition of G/L
(w/o special S/H nonrecognition provision)
• Ex. 1• S/H contributes properties X, Y, and Z to Newco Corp. in
exchange for $300 stock and $200 debt. [W/O nonrecognition]
Prop. Prop. Step 2 Step 3A Property Basis FMV G/Lreal G/L recog.
– X 100 200 100 100
– Y 150 200 50 50
– Z 150 100 (50) (50) Basis: $300 in stock and $200 in debt
• Corp.: 0 gain [Step 5]. Also, basis is 200 + 200 + 100.
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Under the S/H Non Recognition Provision
• S/H– 3A. Non recognition of all/part of G/L
• Loss is not recognized on any property transferred
• Gain recognized on a property is the lesser of gain realized or “boot” applicable to the property
– 3B. Basis of stock is “exchanged basis” New basis = old basis + gain recognized - boot received
• Corp.--excluded gain [Step 5]; transferred basis
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Under the Non Recognition Provision
• S/H– Ex. 2 [Facts same as Slide 5, but nonrecognition provision applies]
– 3A. Non recognition of all/part G/L• Prop. Basis FMV G/Lreal Boot G/Lrec.
X 100 200 100 80 80 Y 150 200 50 80
50 Z 150 100 (50) _40 __0
• Total 400 200 130– 3B. Basis of stock is “exchanged basis”
• 400 + 130 - 200 = 330
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Under the Non Recognition Provision
• Corp. [Ex. 2]
– No G/L on issuance of its own stock [Step 5]
– Transferred basis in property• Property basis = S/H’s basis + S/H’s gain recognized
• Unclear--how to apportion the increase from a S/H’s gain among assets transferred to the corp.
• Prop. X $100 + $80 = $180
• Prop. Y $150 + $50 = $200
• Prop. Z $150 + $ 0 = $150
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Shareholder Non Recognition--
Requirements
• Transfer of Property to the corporation– by one or more persons
• In exchange for Stock – Or in exchange for stock and “boot”
• Resulting in 80% Control immediately after the transfer– by the persons who transfer property
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Liabilities Burdening Transferred Property or Assumed by the Corporation
• Should liabilities be considered as “boot” – in Step 2 (amount realized)?– in Step 3A (recognition of gain)? – in Step 3B (basis of stock)?
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Liabilities Burdening Transferred Property or Assumed by the Corporation
• Should liabilities be considered as “boot” • in Step 2 (amount realized)--yes
• in Step 3A (recognition of gain)
– No, generally– Exception #1, yes if “bad” motive in incurring any liability
Exception #2, liabilities* in excess of basis
• in Step 3B [basis of stock = basis of property + gain recognized - “boot”]--yes*– [*Do not count as “boot” liabilities which give rise to a deduction when
paid, accounts payable of cash method taxpayer and liabilities of accrual method taxpayer with no economic performance.]
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Liabilities
• Ex. 3. S/H transfers to corporation in a 351 transaction land worth $300 and subject to a $200 mortgage, when his/her basis is alternatively $250/$150, in exchange for stock worth $100. $250 $150– Step 2, gain realized of $ 50 $150– Step 3A: gain recognized of $ 0 $ 50– Step 3B: stock basis of $ 50 $ 0
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Choices
• Alternatives for making property available to the corporation:– 1. Transfer in exchange for stock (351)– 2. Recognition of gain (avoiding 351)– 3. Transfer facilitating later withdrawal
– Loan of funds
– Lease of tangible assets
– License of intangible assets
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Avoidance of Non Recognition
• Would the parties ever want to avoid the non recognition provision? Perhaps– Possible double income
– Appreciated property to be transferred to the corp. is likely to be sold soon, &/or is a 1221/1231 asset to the S/H but will be “ordinary” to the corporation
• Ex. 4: B will transfer farm land with a basis of $200. (i) B can sell it to a 3rd person for $500 as it is. (ii) Or B can develop it for an additional cost of $300 and sell the lots for $1,000. (iii) Or B can sell it to his/her corporation for $500; the corporation would develop it for an additional cost of $300 and sell the lots for $1,000.
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Avoidance of Non Recognition
• 1. Avoid 80% control, i.e., bust 351.
• 2. Separate sale to the corp. or a subsidiary of the corp.,
• [e.g., for cash, corporation debt, &/or non qualified preferred stock.]
• 3. “Boot” • [e.g., cash, corporation debt, &/or non qualified preferred stock.]
• 4. Liabilities burdening property or assumed by the corporation--either bad motive, or excess liabilities.
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Transfers Facilitating Later Withdrawal
• Some possibilities• Money• Equipment• Real estate• Intangible
• Factors• Will the S/H need the property?• Will the S/H want to withdraw the property from the
corporation?
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3.2 Capital Structure
• Common stock
• Preferred stock
• Debt (accounts and notes receivable)
• Leases & licenses
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Stock
• Losses– CL, unless 1244 (“small business stock”)
• Gains– 50% deduction, 28% rate for 1202 (“qualified
small business stock”)
• The Subchapter S election• No preferred stock outstanding
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Debt
• Is debt in substance equity? “Cliff” treatment.• Factors
• Debt: equity ratio. 3:1 v. 9:1
• Essential assets
• Subordination
• Convertible into stock
• Payment of interest/principal contingent on profits
• Formalities
• Interest and principal paid when due?
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Debt
• Is debt in substance equity? “Cliff” treatment.• Factors
• Debt: equity ratio. 3:1 v. 9:1
• Essential assets
• Subordination
• Convertible into stock
• Payment of interest/principal contingent on profits
• Formalities
• Interest and principal paid when due?
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Debt
• Losses on debt– Holding for business reasons
– Ordinary loss– E.g., an employee-S/H lends money to the corporation
principally to protect his/her job.
– Holding for investment or personal reasons– Corp. S/H owning 80% of operating subsidiary debtor—
ordinary loss– Other creditor--capital loss
» “Securities”: probable LTCL» Other: STCL automatically
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Leases and Licenses
• “Cliff” treatment not applicable.
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