Exam 18: Corporations: Organization and Capital Structure

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.

In order to encourage the redevelopment of its urban center, the city of Birmingham contributes undeveloped land (fair market value of $900,000) and cash of $350,000 to Blue Corporation. Within the year, Blue constructs a new office building at the site at a cost of $850,000.

Lark City donates land worth $300,000 and cash of $100,000 to Orange Corporation as an inducement to locate in the city. Four months later, Orange purchases additional land and a building at a cost of $500,000 and moves its operations to Lark City. Ann, the sole shareholder, contributes equipment (basis of $70,000 and fair market value of $200,000) to help Orange in its new operations. What are the tax consequences of these transfers to Orange Corporation?

Tom and George form Swan Corporation with the following investments: Tom transfers machinery worth $100,000 (basis of $40,000), while George transfers land worth $90,000 (basis of $20,000) and services rendered in organizing the corporation worth $10,000.Each is issued 25 shares in Swan Corporation.With respect to the transfers:

The definition of property for purposes of § 351 includes unrealized receivables transferred by a cash basis taxpayer.

When incorporating her sole proprietorship, Samantha transfers all of its assets and liabilities. Included in the $30,000 of liabilities assumed by the corporation is $500 that relates to a personal expenditure. Under these circumstances, the entire $30,000 will be treated as boot.

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

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.

Earl and Mary form Crow Corporation.Earl transfers property, basis of $200,000 and value of $1,600,000, for 50 shares in Crow Corporation.Mary transfers property, basis of $80,000 and value of $1,480,000, and agrees to serve as manager of Crow for one year; in return Mary receives 50 shares of Crow.The value of Mary's services is $120,000.With respect to the transfers:

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:

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.

When depreciable property is transferred to a controlled corporation under § 351, any recapture potential disappears and does not carry over to the corporation.

In 2005, Donna transferred assets (basis of $300,000 and fair market value of $250,000) to Egret Corporation in return for 200 shares of § 1244 stock. Due to § 351, the transfer was nontaxable; therefore, Donna's basis in the Egret stock is $300,000. In 2006, Donna sells 100 of these shares to Walter (a family friend) for $100,000. In 2012, Egret Corporation files for bankruptcy, and its stock becomes worthless.

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

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?

For § 351 purposes, stock rights and stock warrants are included in the definition of "stock."

Section 351 (which permits transfers to controlled corporations to be tax deferred) can be justified under the wherewithal to pay concept.

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

Sarah and Tony (mother and son) form Dove Corporation with the following investments: cash by Sarah of $65,000; land by Tony (basis of $25,000 and fair market value of $35,000).Dove Corporation issues 400 shares of stock, 200 each to Sarah and Tony.Thus, each receives stock in Dove worth $50,000.

Joe and Kay form Gull Corporation.Joe transfers cash of $250,000 for 200 shares in Gull Corporation.Kay transfers property with a basis of $50,000 and fair market value of $240,000.She agrees to accept 200 shares in Gull Corporation for the property and for providing bookkeeping services to the corporation in its first year of operation.The value of Kay's services is $10,000.With respect to the transfer: