Exam 4: Corporations: Organization and Capital Structure

Four individuals form Chickadee Corporation under § 351.Two of these individuals,Jane and Walt,made the following contributions: 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.

All accounts payable of a cash basis taxpayer are included as liabilities under § 357(c)in determining whether liabilities exceed basis.

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?

The control requirement under § 351 requires that the person or persons transferring property to the corporation,immediately after the transfer,own stock possessing at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation.

For transfers falling under § 351,what are the holding period rules for stock received by the shareholder and for the assets transferred to the corporation?

Adam transfers cash of $300,000 and land worth $200,000 to Camel Corporation for 100% of the stock in Camel.In the first year of operation,Camel has net taxable income of $70,000.If Camel distributes $50,000 to Adam:

Tina incorporates her sole proprietorship with assets having a fair market value of $100,000 and an adjusted basis of $110,000.Even though § 351 applies,Tina may recognize her realized loss of $10,000.

Wren Corporation (a minority shareholder in Lark Corporation)has made loans to Lark Corporation that become worthless in the current year.

In a § 351 transfer,a shareholder receives boot of $10,000 but ends up with a realized loss of $3,000.Only $7,000 of the boot will be taxed to the shareholder.

The use of § 351 is not limited to the initial formation of a corporation,and it can apply to later transfers as well.

Eileen transfers property worth $200,000,basis of $60,000,to Goldfinch Corporation.In return,she receives 80% of the stock in Goldfinch Corporation worth $180,000,and a long-term note,executed by Goldfinch and made payable to Eileen,worth $20,000.Eileen will recognize no gain on the transfer.

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

The reason for § 351 (which permits transfers to controlled corporations to be tax free)can be justified under the wherewithal to pay concept.

George transfers cash of $150,000 to Grouse Corporation,a newly formed corporation,for 100% of the stock in Grouse worth $80,000 and debt in the amount of $70,000,payable in equal annual installments of $7,000 plus interest at the rate of 9% per annum.In the first year of operation,Grouse has net taxable income of $40,000.If Grouse pays George interest of $6,300 and $7,000 principal payment on the note:

Rick transferred the following assets and liabilities to Warbler Corporation. 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).

If both §§ 357(b)and (c)apply to the same transfer (i.e.,the liability is not supported by a bona fide business purpose and also exceeds the basis of the properties transferred),§ 357(b)predominates.

A shareholder transfers a capital asset to Red Corporation for its stock. If the transfer qualifies under § 351,Red's holding period for the asset begins on the day of the exchange.

Lucy and Marta form Blue Corporation. Lucy transfers land (basis of $40,000 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.

Leonard transfers equipment (basis of $40,000 and fair market value of $100,000)for additional stock in Green Corporation. After the transfer,Leonard owns 90% of the stock. Leonard had claimed depreciation of $50,000 on the equipment prior to transferring it to Green Corporation. With respect to the transfer: