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Exam 18: Corporations: Organization and Capital Structure

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Question 1

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Sean,a sole proprietor,is engaged in a service business and uses the cash basis of accounting.In the current year,Sean incorporates his business by forming Aqua Corporation.In exchange for all of its stock,Aqua receives: assets (basis of $400,000 and fair market value of $2 million),trade accounts payable of $110,000,and loan due to a bank of $390,000.The proceeds from the bank loan were used by Sean to provide operating funds for the business.Aqua Corporation assumes all of the liabilities transferred to it.

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Question 2

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What are the tax consequences if an individual investor incurs a loss on the following:

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A shareholder's holding period for stock received under § 351 includes the holding period of the property transferred to the corporation.

Three individuals form Skylark Corporation with the following contributions: Cliff,cash of $50,000 for 50 shares; Brad,land (fair market value of $20,000)for 20 shares; and Ron,cattle (fair market value of $9,000)for 9 shares and services (fair market value of $21,000)for 21 shares.Section 351 will not apply in this situation because the control requirement has not been satisfied.

Pat,Maria,and Lynn are equal shareholders in Lime Corporation.Lime has assets with a basis of $150,000 and a fair market value of $1,200,000.In the current year,Pat lends Lime Corporation $200,000 and Maria lends it $150,000.Both notes bear interest at the rate of 8% per annum.Lime Corporation has no other debt outstanding.Lynn leases machinery to Lime Corporation for an annual rental of $16,000.

In a § 351 transaction,if a transferor receives consideration other than stock,the transaction can be taxable.

Ashley,a 70% shareholder of Wren Corporation,transfers property with a basis of $250,000 and a fair market value of $900,000 to Wren Corporation for additional stock.Ashley owns 78% of Wren after the transfer.Two other shareholders in Wren transfer a nominal amount of property to Wren along with Ashley's transfer so that Ashley and the two shareholders own 90% of the Wren stock after the transfer.Does Ashley have taxable gain on the transfer?

When forming a corporation,a transferor-shareholder may choose to receive some corporate debt along with stock.Identify some of the issues the transferor must consider when deciding whether debt should be a part of the transaction. Significant tax differences exist between debt and equity in the capital structure.

A shareholder lends money to his corporation in his capacity as an investor.If the loans become worthless,a business bad debt results.

Amy owns 20% of the stock of Wren Corporation,which she acquired several years ago at a cost of $10,000.Amy is Vice-President of Wren and earns a salary of $80,000 annually.Last year,Wren Corporation was experiencing financial problems,and Amy loaned the corporation $25,000.In the current year,Wren becomes bankrupt,and both her stock investment and the loan become worthless.Amy has a nonbusiness bad debt deduction this year of $25,000.

In determining whether § 357(c)applies,assess whether the liabilities involved exceed the bases of all assets a shareholder transfers to the corporation.

In order to encourage the development of an industrial park,a county donates land to Ecru Corporation.The donation does not result in gross income to Ecru.

Eve transfers property (basis of $120,000 and fair market value of $400,000) to Green Corporation for 80% of its stock (worth $350,000) and a long-term note (worth $50,000) ,executed by Green Corporation and made payable to Eve.As a result of the transfer:

Similar to like-kind exchanges,the receipt of "boot" under § 351 can cause loss to be recognized.

Erica transfers land worth $500,000,basis of $100,000,to a newly formed corporation,Robin Corporation,for all of Robin's stock,worth $300,000,and a 10-year note.The note was executed by Robin and made payable to Erica in the amount of $200,000.As a result of the transfer:

The transfer of an installment obligation in a transaction qualifying under § 351 is a disposition of the obligation that causes gain to be recognized by the transferor.

Since services are not considered property under § 351,a taxpayer must report as income the fair market value of stock received for such services.

Tim,a cash basis taxpayer,incorporates his sole proprietorship.He transfers the following items to newly created Wren Corporation. With respect to this transaction:

Sarah and Emily form Red Corporation with the following investments: Sarah transfers computers worth $200,000 (basis of $80,000) ,while Emily transfers real estate worth $180,000 (basis of $40,000) and services (worth $20,000) rendered in organizing the corporation.Each is issued 600 shares in Red Corporation.With respect to the transfers:

Kevin and Nicole form Indigo Corporation with the following transfers: inventory from Kevin (basis of $360,000 and fair market value of $400,000) and improved real estate from Nicole (basis of $320,000 and fair market value of $375,000) .Nicole,an accountant,agrees to contribute her services (worth $25,000) in organizing Indigo.The corporation's stock is distributed equally to Kevin and Nicole.As a result of these transfers: