Exam 18: Corporations: Organization and Capital Structure

Perry organized Cardinal Corporation 10 years ago by contributing property worth $2 million (basis of $450,000) for 2,500 shares of stock in Cardinal, representing 100% of the stock in the corporation.Perry later gave each of his children, Brittany and Julie, 750 shares of stock in Cardinal Corporation.In the current year, Perry transfers property worth $600,000 (basis of $150,000) to Cardinal for 1,000 shares in the corporation.What gain, if any, will Perry recognize on the transfer?

Kirby and Helen form Red Corporation.Kirby transfers property, basis of $20,000 and value of $300,000, for 100 shares in Red Corporation.Helen transfers property, basis of $40,000 and value of $280,000, and provides legal services in organizing the corporation.The value of her services is $20,000.In return Helen receives 100 shares in Red Corporation.With respect to the transfers:

Penny, Miesha, and Sabrina transfer property to Owl Corporation for 75% of its stock.Nancy, their attorney, receives 25% of the stock in Owl for legal services rendered in incorporating the business.What are the tax consequences of these transactions? How should this transaction have been handled?

When a taxpayer transfers property subject to a mortgage to a controlled corporation in an exchange qualifying under § 351, the transferor shareholder's basis in stock received in the transferee corporation is increased by the amount of the mortgage on the property.

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?

If a shareholder owns stock received as a gift from her mother, it cannot be § 1244 stock.

Carmen and Carlos form White Corporation. Carmen transfers cash of $100,000 for 100 shares in White. Carlos transfers property (basis of $20,000 and fair market value of $80,000) and agrees to serve as manager of White Corporation for one year; in return, Carlos receives 100 shares in White. The value of Carlos's services is $20,000. White Corporation can deduct $20,000 as compensation expense for the value of the services Carlos will render.

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.

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

A transferor who receives stock for both property and services cannot be included in the control group in determining whether an exchange meets the requirements of § 351.

Carl transfers land to Cardinal Corporation for 90% of the stock in Cardinal Corporation worth $20,000 plus a note payable to Carl in the amount of $40,000 and the assumption by Cardinal Corporation of a mortgage on the land in the amount of $100,000.The land, which has a basis to Carl of $70,000, is worth $160,000.

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.

Kim, a real estate dealer, and others form Eagle Corporation under § 351.Kim contributes inventory (land held for resale) in return for Eagle stock.The holding period for the stock includes the holding period of the inventory.

Tara incorporates her sole proprietorship, transferring it to newly formed Black Corporation.The assets transferred have an adjusted basis of $240,000 and a fair market value of $300,000.Also transferred was $10,000 in liabilities, $1,000 of which was personal and the balance of $9,000 being business related.In return for these transfers, Tara receives all of the stock in Black 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.

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

George (an 80% shareholder) has made loans to Mountainview Corporation that become worthless in the current year. George is not employed by Mountainview.

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(c) predominates.

Allen transfers marketable securities with an adjusted basis of $120,000, fair market value of $300,000, for 85% of the stock of Heron Corporation.In addition, he receives cash of $40,000.Allen recognizes a capital gain of $40,000 on the transfer.