Exam 18: Corporations: Organization and Capital Structure

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

Stock in Merlin Corporation is held equally by Jane,Eve,and Fred.Merlin seeks additional capital to buy a valuable tract of land that will cost $6,000,000.Jane,Eve,and Fred propose to loan Merlin $2,000,000 each,taking from Merlin a $2,000,000 ten-year note with interest payable annually at five points above the prime rate.Merlin Corporation has current taxable income of $7,000,000.How are the payments on the notes treated for tax purposes?

A shareholder contributes land to his wholly owned corporation but receives no stock in return.The corporation has a zero basis in the land.

In structuring the capitalization of a corporation,the tax law is neutral for the investor as to debt versus equity financing.

In order to induce Yellow Corporation to build a new manufacturing facility in Knoxville,Tennessee,the city donates land (fair market value of $400,000) and cash of $100,000 to the corporation.Several months after the donation,Yellow Corporation spends $450,000 (which includes the $100,000 received from Knoxville) on the construction of a new plant located on the donated land.

Rita forms Finch Corporation by transferring land (basis of $125,000;fair market value of $750,000) which is subject to a mortgage of $375,000.Two weeks prior to incorporating Finch,Rita borrows $125,000 for personal purposes and gives the lender a second mortgage on the land.Finch Corporation issues stock worth $250,000 to Rita and assumes the two mortgages on the land.What are the tax consequences to Rita and to Finch Corporation?

Nancy,Guy,and Rod form Goldfinch Corporation with the following consideration. Adjusted Basis Fair Market Value From Nancy- Cash $120,000 $120,000 Inventory 90,000 130,000 From Guy- Land and building 120,000 250,000 From Rod- Legal and accounting services to incorporate -0- 50,000 ​ Goldfinch issues its 500 shares of stock as follows: 250 to Nancy,200 to Guy,and 50 to Rod.In addition,Guy gets $50,000 in cash. a.Does Nancy,Guy,or Rod recognize gain (or income)? b.What basis does Guy have in the Goldfinch stock? c.What basis does Goldfinch Corporation have in the inventory? In the land and building? d.What basis does Rod have in the Goldfinch stock?

Rick transferred the following assets and liabilities to Warbler Corporation. Adjusted Basis Fair Market Value Building $210,000 $225,000 Equipment 45,000 75,000 Trucks 15,000 30,000 Mortgage (held for four years) on building 30,000 30,000 ​ In return,Rick received $75,000 in cash plus 90% of Warbler Corporation's only class of stock outstanding (fair market value of $225,000).

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.

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. a.Does Sean recognize any gain on the incorporation? Explain. b.What basis does Sean have in the Aqua stock? c.What basis does Aqua Corporation have in the assets it receives?

Rhonda and Marta form Blue Corporation.Rhonda transfers land (basis of $55,000 and fair market value of $180,000) for 50 shares plus $20,000 cash.Marta transfers $160,000 cash for 50 shares in Blue Corporation.

Three individuals form Skylark Corporation with the following contributions: Cliff,cash of $50,000 for 50 shares;Brad,land worth $20,000 (basis of $11,000) for 20 shares;and Ron,cattle worth $9,000 (basis of $6,000) for 9 shares and services worth $21,000 for 21 shares.

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:

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:

Rob and Fran form Bluebird Corporation with the following investments. Adjusted Basis Fair Market Value From Rob- Cash $400,000 $400,000 From Fran- Land 500,000 440,000 ​ Each receives 50% of Bluebird's stock.In addition,Fran receives cash of $40,000.One result of these transfers is that Fran has a:

Hazel transferred the following assets to Starling Corporation. Adjusted Basis Fair Market Value Cash $120,000 $120,000 Machinery 48,000 36,000 Land 108,000 144,000 ​ In exchange,Hazel received 50% of Starling Corporation's only class of stock outstanding.The stock has no established value.However,all parties believe that the value of the stock Hazel received is the equivalent of the value of the assets she transferred.The only other shareholder,Rick,formed Starling Corporation five years ago.

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

Four individuals form Chickadee Corporation under § 351.Two of these individuals,Jane and Walt,made the following contributions: Adjusted Basis Fair Market Value From Jane- Cash $360,000 $360,000 Patent -0- 40,000 From Walt- Equipment (depreciation claimed of $100,000) 240,000 370,000 Both Jane and Walt receive stock in Chickadee Corporation equal to the value of their investments.

A city contributes $500,000 to a corporation as an inducement to locate in the city.Within the next 12 months,the corporation uses the money to purchase property.The corporation has income of $500,000 and must reduce its tax basis in the property by the same amount.

Basis of appreciated property transferred minus boot received (including liabilities transferred) plus gain recognized equals basis of stock received in a § 351 transfer.