Professional Documents
Culture Documents
Spring 2010
Influential Policies
Double Tax
Rule: Corporation is taxed on its earnings and Shareholders are taxed when they receive
dividends.
Prior Rule: General Utilities Doctrine Distributions were non-taxable events.
DT of C increases the cost of operating a business as a C Corp and often provides TP’s an
incentive to choose a partnership or S corp. for business and investment activities
Rate Structure:
In Past, Usually, min. individual tax rate has exceeded the corp. tax rate and gave
incentive to operate as a C corp.
Ex: 1980 and 1987 in class we saw that there was a big difference
Current Day: Not as clear because indiv. And corp. rates are approx. 35% and thus it is a
fact and circumstance test.
Non Recognition
Corp. and partnership transactions qualify for no recognition treatment b/c they are mere
changes in form which result in continuity of investment.
Corporation Defined
Defined under §7701(a)(3)
Associations, joint stock companies, and insurance companies
Certain unincorporated entities “associations” are treated as corporations for federal tax
purposes
Pre-1997 Regulations
Six Characteristics of a “pure corporation”
Associates
An objective to carry on a business and divide the profits
Continuity of Life
SH goes bankrupt or dies, no affect on corporation
Centralization of Management
BOD has power and responsibility of operating the business.
Liability for debts limited to Corporate Property
SH not personally liable
Free Transferability of interest
SH can dispose of shares at anytime
Ex: You own GM, and you can transfer your interest to someone else and that transferee
will step into your shoes.
So if there was an unincorporated entity, and it characteristics EXCEEDED any non
corporate characteristic, it was a corporation for tax purposes
State laws created LLC and now there was a blur b/t a corp. and unincorporated entity
New Regulations were proposed and “check the box” regulations were finalized in 1997.
No matter what, once you are publicly traded you are a corporation for tax purposes.
Existing Entities:
An entity in existence before 1997, generally retains the same classification that it had
under the prior association regulations
Exception- Single owner entity that claims to be a partnership
Election under REG§301.7701-3(c)
An entity wishes to change its classification must file an election, which is effective up to
75 days before or 12 months after it file
Must be:
(1) Signed by each member of the entity, including prior members affected by
retroactive elections OR
(2) AN officer, manager or member authorized to make the election.
Can not change for 60 months, unless Service p[permits the change and 50% of
ownership interests are owned by persons who did not own any interests when the
election was first made
IRC:
§351(a), (c), (d)(1), (d)(2)
§358(a),(b)(1)
§362
§368
§1032(a)
§1223(1)
§1221(2)
§1245(b)(3)
Reg:
§1.351-1(a)
§1.351-1(b)
§1.358-1(a)
§1.358-2(b)(2)
§1.362-1(a)
§1.1032-1(a)(3)
A. Introduction:
§1001(a)
a TP who transfers property to a newly formed corp., in exchange for stock would
recognize a gain or loss measured by the difference b/t FMV and AB.
AR – AB = Gain (loss)
Also, Corp may realize on issuance of stock for property.
§351
Allows no G or L to newly formed S or C Corps.
§1032(a) provides that a
corp., does not recognize a gain or loss when it receives money or property in exchange
for stock.
Rationale these transactions are mere changes in form of SH investments and thus non-
taxable events.
§351 preserves unrecognized gain or loss in the SH stock’s basis under §358 and in
corp.’s basis in the transferred property under §362.
Recognition of Gain or Loss (Transferor)
§351 states:
Certain transfer of property to a newly formed or preexisting controlled (80% owned)
corporation are not taxable events.
Unrecognized gain or loss is preserved through transferred and exchanged basis rules
Basically no gain or loss will be recognized if property is transferred and all elements
are met.
Normal §1001(a) Rule does not apply.
Rationale Congress felt that a gain or loss should not be recognized because the
transferor still has a financial interest in the property and still has control.
There is a continuity of proprietary interest. (continuing investment)
Remember the gain is not forgiven, rather it is deferred until Transferor sells corp.’s
stock.
(a) Property
Cash, inventory, accounts receivable, patents and other intangibles such as goodwill and
industrial know-how
Property does not include:
Past, present or future services
(b) Transfer
All substantial rights in the property must be transferred
So if you transfer a limited license element has not been met.
(2) The Property must be transferred solely in exchange for stock of the transferee
corporation
(3) The transferors, as a group must be in control under §368(c)of the corp., immediately
after the exchange.
(a) Control
§368(c) defines control as:
People transferring property must own at least 80% of the total combined voting power of
all classes of stock entitled to vote and at least 80% of each class of nonvoting stock.
Simultaneous exchanges:
Reg §1.351-1(a)(1) Simultaneous exchanges are not required where the rights of the
parties have been “previously defined” and the agreement proceeds with an “expedition
consistent with orderly procedure”
Example 1:
A receives 50 shares of voting stock, B receives 50 share of nonvoting common stock,
and C receives 50 shares of nonvoting preferred stock that is not nonqualified preferred
stock.
Control test is satisfied because the property transfers, as a group own at least 80% of
class of stock
Example 2:
Now C, gets stock for services, so 100/150 is transferred and this is only 67% and thus
not 80% and control has not been met. A and B must recognize gain and loss on their
property.
Shareholder’s Basis
§351 Transferor’s basis in the stock received will equal his basis in the transferred
property immediately prior to the exchange §358(a)(1).
For more than 1 class of Stock aggregate basis is determined under §358(a)(1) as
allocated among all classes of stock received in proportion to the FMV of each class
§358(b), Reg §1.358-2(a)(2)
§358 (FILL IN) used for determining adjusted Basis in Stock and Boot Received
Hypo 1:
A transfer land (§1231 asset) held long term with a basis of 10k and FMV of 60k, and
inventory with a basis of 30k and a value of 40k, in exchange for 100 shares of Newco
common stock with a FMV of 100k.
Issue 1: Is this a §351 transaction?- Yes, on exam analyze all the properties and say
that it is
Issue 2: What is transferor’s basis in the stock?
A’s basis is 40,000 because the rule under §358(a)(1) is the transferor’s basis in the stock
received will equal his basis in the property immediately prior to the exchange.
Here, transferor’s basis in the land is 10k, and in the inventory is 30k, so the total basis is
40k.
Issue 3: What is A’s Holding Period?
A’s Holding period depends on whether it is a capital, 1231 asset or ordinary income.
Here, the land is a 1231 asset and the inventory is ordinary income.
Under Rev. Rul 85-164, there is a split holding period allocated in proportion to the FMV
of the transferred asset.
Total FMV of property is 60k land and 40k inventory so 100k, 60% is land and 40% is
inventory.
So for holding period, 60% of the time is of the land, and 40% of the stock is from the
day of the exchange.
Issue 4: Say that A sells stock the next day, what is his gain or loss on the stock?
Gain AR- AB 100k- 40k= 60k
60k*60%=36k (Land tack on so LTCG)
60k*40%=24k(Ordinary Income so ST capital gain)
Issue 5: Newco’s Basis and Holding Period
Newco’s basis in land is 10k and 30k in the inventory under §362(a)
Holding PeriodTacked under §1223(a)(2)
Hypo 2:
Same facts as above, except now A receives 80 shares of Newco Common stock and 20
shares of Newco preferred stock. Remember combined basis in both was 40k so:
As basis in both classes of stock is 40k and 80% is common, so 32k and 20% is preferred,
so 8k.
Holding Period
Split Holding Period for each share of common and preferred stock
60% tacked from land and 40% commencing on date of exchange.
Page 64 Problem:
A, B, C, D, E form X Corporation to engage in a manufacturing business.
X issues 100 shares of common stock.
A transfers 25k for 25 shares
B transfers inventory with a value of 10k and a basis of 5k for 10 shares
C transfers unimproved land with a value of 20k and a basis of 25k for 20 shares
D transfers equipment with a basis of 5k and a value of 25k (prior depreciation was 20k)
for 25 shares
E transfers 20k note for 20 shares. E received the note in exchange for land with a 2k
basis he sold last year. The note is payable over a 5 year period beg. In two years at 4k
per year plus market rate interest
Issues:
What are the tax consequences (G or L recognized)
Does 351 apply?
1. Yes
2. Yes
3. In control yes
Effect on Transferor:
ABFMVAmount of sharesGain realizedGain RecognizedBasisHolding PeriodA-Cash---
25k250025kNo Tack on- New Holding PeriodB-Inventory5k10k205k05kNo Tack on
because does not fit categoriesC-Land25k20k20(5k)025kTack On! Capital assetD-
Equipment5k25k25 shares20k05kTack onE- Note2k(amount paid)20k2018k02kOnly
tack on if land is a capital improvement land.
Key Things to rememember:
Transferor takes basis. (find out rule if AB>FMV)
For the equipment, the depreciation is normally a gain under §1245, but under §351 it
will not be an actual realized gain!
(c)- Parcels
(d) If there is an inherent gain and also a gain to the SH, both will be taxed. Double tax
here!
Rationale- else everyone would try to make it a capital gain and always escape ordinary
gain.
CONTROL Immediately after the exchange
Transferor’s of property must have control of “NEWCO” immediately after the
exchange.
Issue when a transferor disposes of stock shortly after an incorporation exchange,
§1.351-1(a)(1)page 1146 of code - immediately after exchange does not require
simultaeneus transfer. Can be at different time and considered the same transaction - -
does include time where rights of parties were previously defined and completed in a
reasonable time frame.
Case Law about two transfers that are interdependent
Binding Agreements to Dispose of Stock
If a SH disposes of stock received in exchange for property pursuant to a prearranged
binding agreement entered into prior to an incorporation exchange, the control test is
applied after the stock disposition
So look at situation immediately after the transfer!
A disposition of more than 20% of voting power or more than 20% of any class of
nonvoting stock will cause a loss of control because the person ultimately acquiring the
stock was not a transferor of property to NEWCO.
Example:
A transfers land with a basis of 10k and value of 60k in exchange for 60 shares of Newco
(60%) and B transfers equipment with Basis and FMV of 40 for 40 shares (40%)
Two months later, pursuant to a prearranged binding agreement B transfers all her Newco
stock to C for 40k cash.
Control test is applied after the transfer to C, since C was not a transfer or property to
Newco, her ownership cannot be counted in testing for control, and A only owns 60% of
NEWCO immediately after exchange and thus 80% is not satisfied.
A must recognize a 50k gain on the transfer of land because this is not a §351 transaction
Intermountain
Intermountain Lumber
Argued that trans was not a good 351 (bc it wanted higher basis to depreciate).
IRS argued it was a good 351 trans. Bc lower depreciation deduction (taking shooks
basis)
Rule §351 – no gain or loss recognized if prop is transferred for stock IMMEDIATELY
AFTER the exchange.
Technically this happened but there was an agreement for Shook to sell 50% of stock
(over time) to Wilson.
Ct says control must include freedom of action – was contracted to sell 50% of stock.
Only applies if there is a binding obligation.
Court justifies this holding by – saying that 351 affects non-recognition of gain or loss
that is only a change of form --- here there is more than a mere change of form.
Prof says this is a bad decision -
If prior to time you make transfer to a corporation, there is a pre-existing binding
agreement where transferor will see so he loses control, not a good 351 transaction
RJ This case does not further §351 policy for formation of corporation, rather it
imposes an obligation.
Hypo: A owns property with a FMV of 100 and Basis of 10k and sells B an interest of
30%, so now A only has 70%, so B has a gain of 3k, and now B says A you get 100%, A
has to recognize the 27k (30k - .3 * 10) = 27k
A does not want this so
A transfer biz to new corp called X. pursuant to agreement A agrees to transfer 30% of
stock to B - thus this is not a good 351 (intermountain says this is not 351 but 1001)
A would recognize a gain of 90K
Heta go see RJ
Special Problems:
Stock for Services
§351(d)(1) stock issued for services is not considered as issued in return for property,
and thus this is a taxable event! §351(d)(1) and Reg §1.351-1(a)(1)(i)
Tax consequences of this transaction is determined under §61 and §83
Problem: A person who receives stock solely in exchange for services may cause the
other parties to the incorporation to recognize gain or loss.
HYPO:
TransferorTransferred AssetAdjusted BasisFMVStock
ReceivedCLand20k50k50%SCashN/A10k10%ServicesN/A40k40%
Here, this works as a good §351 transaction under §351(a) Because both C and S make
up 100%, thus all stock received can be counted for purposes of 80% control
requirement.
Exception: Reg §1.351-1(a)(1)(ii)
If the value of the property transferred is of relatively small value relative to the stock
received for services and the primary purpose of the property transfer is to qualify the
exchanges of other transferor for non-recognition, then CANNOT use for 80%
RELATIVELY SMALL VALUE under Rev Proc. 77-37
Property is not relatively small if it equals to or in excess of 10% of the FMV of stock
already owned by the transferor.
So Compare the other property to the services, and if the property is relatively small,
probably won’t be §351 transaction
Hypo:
A receives 70 Shares of CS (70k) in exchange for land (FMV-70k and basis-20k) and B
receives 30 shares (FMV-30k) in exchange for 1k cash and services.
A70% (property)
B 30%,
B receives 1k cash, and 29k services, so the cash is of a relatively small in comparison to
the services, (less than 10%) so not a §351 transaction, and both A and B recognize gain
and loss, because A does not have more than 70%
Hypo 2:
Now, B receives 5 shares (5k) for 5k cash and 25 shares for 25k services.
Here, cash is for 5k and it is 10% of 25k which is 2,500, so will be a 351 transaction, but
B STILL RECOGNIZES a gain on the stock received for services So there is a gain of
the 25k as ordinary income.
(b) Same as (a) above, except the transfers by A and B were part of a single integrated
plan.
§368(c)- look at A and B collectively, and now they own 100% of voting and nonvoting
so they both qualify under 351 this transaction
A has same consequences as above
B- B’s basis is 1k and corp takes basis of 1k.
§1231- real estate with trade or business, so B can tack on if property is either a capital
asset or 1231 property and the corp., can take the same basis
(c) Same as (b) above, except A transferred 25 of her 50 shares to her daughter as a gift
on 3/5 (3 days after B’s transfer). What if A’s gift was on 1/5?
A get shares on 1/5 and then transfers to daughter
Here, there is no change and A still has control – because intermountain says that there
need be only a freedom of action with regard to the stock after completion of the initial
transaction.
Hypo- Say A received it as a binding contractual relaton
No §351- b/c under binding agreement there is no control
Here he was OBLIGATED to sell, 50% so not 80% and thus no control
(d) Same as (b) above, except that two months after B’s transfer, A sold 15 shares to E
pursuant to a preexisting oral understanding w/o which Newco would not have been
formed.
Interdependent Test
If two transfers are interdependent they will be treated as part of the same transaction
Here, 15 shares were sold, so now only 70% and requirement has not been made, so not a
§351 transactions.
What if A transfers services for stock (20%)
A pays taxes as ordinary income
B transfers property and retains 80% thus meets 351 test
What if A transfers services for 30% stock
A still pays ordinary income tax
B does not retain 80% - 351 does not apply and must pay tax on the gains.
What if C transfers ppty for 50% and S transfers ppty 10% and services 40%. (thus 60%
of stock transferred for
Does this qualify for 351 treatment?
Yes both C and S both transfer property and retain 100% of stock ownership. (does not
matter that services were used to transfer also.)
However, Reg 1.351-1(a)(1)(ii) if property transferred for the stock is so small compared
to stock transfer for the property and purpose is to create a 351 situation for another
person.. then that person does not qualify as transferring property for the transaction.
Rev proc 77-37 ( FMV of stock received >= 10 % FMV of stock received for services.
Here S would be counted as a property transferor.
10% of 40% is 4 and 10 > than 4 thus transferred property. (this is a deminimus rule)
Problem 2:
Java has operated a chain of coffee houses as a sole proprietorship over the past three
years and is now interested in expanding his horizons and limiting his liability.
To do so, he wishes to incorporate, raise 150k of addl’t capital and hire, an experienced
person to manage the business. He has located Venturer, who is willing to invest 150k
cash and Manager, who has agreed to serve as chief operating officer if the terms are
right
The parties have decided to join forces and form Java Jyve, inc
Java will transfer assets with an AB of 50k and FMV of 200k
Venturer will give 150k Cash, and M will enter into 5 year employment agreement
Java wants control, V wants a guaranteed investment but wants to share in growth of
business, mgr., wants to be fairly compensated (believes her services are worth 80k/year)
(a) J will get 200 shares and V will get 150 shares. M will get a salary of 40k/year and
receive 150 shares. FMV of stock is 1k/share.
500 shares
Java wants >50% of stock, here he only gets 40% so it doesn’t satisfy Java’s goals
J and V have 70% and not 80% so this is not a §351 transaction and will be taxed on
gains.
Managers share do not count because she gets services instead.
So here J’s AB is 50 and FMV is 200, so he has a gain of 150, and Basis of 200k
(FMV)
VBasis of 150k
Manager ordinary income of 40k, and 150k of Shares
(b) same as (a), but M gets compensation of 80/year and will pay 150k for her stock.
Qualifies as a §351, when she pays, because now it is cash and not services.
Where as, V still does not own or have control
Now mgr. gives a note this is still property (unlike services) but manager has to pay the
note eventually and pay service
(c) same as(a) except M will pay 1k for her 150 shares and the incrop., documents specify
she is getting shares in exchange for her cash contribution rather than for future service
Stock is worth 150k and so here FMV of stock is 1k and services is 149k, so here 1k is
relatively small and under regulation not a §351 transaction.
Here J and V, will not have 80% because cannot use it for these purposes.
In General
If a transferor receives property other than stock, e.g. cash, corporate debt, securities,
nonqualified preferred stock or other property, boot, in a §351 transaction,
§351(b) provides that the transferor’s realized gain is recognized to the extent of the cash
and FMV of any other boot received
No Loss Rule Even if boot is received by transferor, no loss is recognized. §351(b)(2).
Character of Gain
Determined by reference to the character of the transferred asset to which the gain is
attributable taking into account the depreciation recapture provision under §1245 and
other applicable characterization rules under §1239
Gain is triggered by the receipt of boot results in increases to the SH basis in the stock
received and the Corp’s basis in the transferred property.
Gain Rule Gain recognized on boot is limited to the gain realized (so it is the lesser of
the boot received or the gain realized)
If property transferred is capital then the recognized gain is capital.
If part capital part ordinary – then you bifurcate the transaction by capital and ord
Step One:
Determine the realized gain on the exchange
Example: A gives property with an AB of 70 and receives 80k stock and 20k cash.
AR-AB 100k-70k30k Realized Gain, RECOGNIZE 20k
Recognized Gain EXTENT OF CASH!!!!!!!!!!!!!!!!!!!!!!!!!!!
§351(b) says gain recognized is to extent of cash AND FMV of boot, so here, the extent
of it is 20k
lesser of boot received or realized gain of pproperty transferred.
Example 2:
A gets 60k cash and 40k stock and gives corp. land with FMV is 100k and 70k is AB.
AR-AB 100k-70k30k, but here cash is 60k, but YOU CAN ONLY RECOGNIZE
30k, so here,
Rule Recognize the lesser of the boot or realized gain
Rule: S351(b) NO LOSS IS RECOGNIZED ON BOOT!
Hypo 1:
A transfers 50k cash in exchange for 50k stock
B transfers a capital assets with Basis of 5k and a value of 30k and equipment with a
basis of 5k and a value of 20k (10k is recapture under §1245) in exchange for 40k stock
and 10k cash
Issue 1: Where is the boot allocated for B?
B has boot of 10k and it is allocated b/t capital asset and equipment in proportion to the
FMV.
Here, 30k is land and 20k is equipment, so 60% goes to land and 40% goes to equipment
So 6k of Capital Gain on capital asset and 4k on ordinary income.
Hypo 2:
Same as Hypo 1, except that B’s basis in 30k capital asset is 40k rather than 5k.
The 10k cash boot is still allocated 6k and 4k to the equipment.
B recognizes 4k of ord. income on the equipment but may not recognize any loss, on the
capital asset.
Installment Boot
§453 A transferor who receives boot in the form of a newco debt instrument may be
allowed to defer recognition of any §351 gain.
Two Parts:
(1) A §351(a) recognition exchange to the extent of the stock (“permitted property)
received by the transferor and (2) a taxable installment sale to the extent of the boot
received
Basis of the transferred property is first allocated to the nonrecognition exchange and any
remaining basis (“Excess basis”) is allocated to the installment sale.
Installment Method
If transferor defers any gain recognized under the §453 installment method, corp. may
increase its basis under §362(a) only when that gain is recognized§1.453-1(f)(3)(ii)
Handout Example:
A transfers property (AB- 20k and FMV-60k) to X in a transaction under §351 and
receives an exchange stock (FMV-10k), cash of 5k and a note of 45k
Step 1: AB of transferred property to the stock up to the amount of the stock FMV
Here, the AB is 20k, and the FMV is 10k, so AB is 10k
Step 2: Remaining amount. Is then allocated to the installment sales portion
Here, it is 10k, so you end up applying the installment sales method:
AR which si 5k cash and 45k note50k
Subtraict AB allocated-10k
Now there is a gain for 40k
Step 3: Gross Profit %-->
Gross Profit (Gain) / Total Sales Price 40k/50k 80%
Gain on cash received is 4k (80% of 5k) and Gain on recognized payments of not is 36k
(80*45k)
Step 4: SH AB in stock:
Elect as though there was no installment method and compute under §351
AB of Transferred Property- FMV of Boot + gain Recognized
So here 20k-50k (note+cash)+40k10k gain
Step 5: Corp’s AB in property received:
AB in the property is equal to the transferor’s AB, which is 20k, and increases AB when
S recognizes gain.
Page 83 problem
A, B, and C form X corp., by transferring the following Assets, each of which has been
held long-term
TransferorAssetABFMVAEquipment §1245
gain15k22kBInventory7k20kLand25k10kCLand20k50k
In exchange,
A receives 15 shares of X common stock (value-15k) 2k cash and 100 shares of preferred
stock with value of 5k)
B receives 15 shares of X Common stock (15k) and 15k cash
C receives 10 shares of X C.S (10k) 5k cash and X’s note for 35k payable in two years.
A- not qualified preferred stock
(a) What are the tax consequences of the transfers to each SH and to X corp?
Step 1 Is this a §351 Transaction
Yes, 100% and control, exchange property, just be aware of services and that they don’t
count.
Step 2 A
A is getting boot in this transaction. So here need to do formula:
Gain Realized is AR- Ab, so here, 17k (15+2) – 15k2k
Here 2k is recognized! - of ordinary income (due to recapture of depreciation)
AB of property given is 15k less 2k(amount of cash) + 2k So here the AB is 15k.
But you need to proportionate by the type of stock, because we have common and
preferred.
15k/20k is common and 5k/20k is preferred, so you have 75% of common 25% of
preferred or 1$ 1,250 basis in common stock and $ 3,750 AB in preferred stock.
Holding period = if held for more than one year its 1231 and tack on permitted. Holding
period is based on the proportion received. Here 2/3 gets a new holding period 1/3 gets a
tack on period. (p. 80)
Regulation:
§1.357-1
§1.357-2
§1.358-3
In General:
§357 (a) Rule: If under §351 exchange, a company assumes a liability of the transferor
SH, the assumption is not boot received by the transferor. Unless the assumption was for
the purpose of avoiding gain – then total amount of liabilities is treated as boot
(recognized gain).
Example:
A transfers land with a basis of 30k and a FMV of 100k and subject to a 10k liability in
exchange for Newco common stock worth 90k (mtg of 10).
(1) What is A’s gain?
0- because the transfer of liability under §357(a), is not boot received and no gain or loss
is recognized.
(2) what is A’s Basis in Newco Stock?
Formula under §358(a)(1)
Transferor’s Basis in property Transferred
(-) Amount of Cash and FMV of Boot (Debt and other non-stock property)
(+) Gain Recognized by transferor
Applied to this formula:
Basis20k -10k – 010k basis
10k basis, preserves 40k in land (60-20=40)
Lessinger
Rule: A TP who transfers his own enforceable note to a controlled corp. in a §351
transaction may avoid recognizing gain under §357(c)
Sine the corporation took the note with a basis equal to its face value; the TP should not
be required to recognize any gain.
Statute does not support this rationale.
Here IRS says that TP has 0 basis but this is an unsettled part of the law!
Excluded Liabilities:
Liabilities assumed by Newco that have not yet bee taken into account by the transferor
for tax purposes (either §162 or increasing the basis for property) are not treated as
“liabilities” for purposes of determining gain recognized under §357(c)(1) or basis under
§358. §357(c)(3) and §358 (d)(2)
Example 1:
A, a cash method TP, transfers 50k cash and 200k AR (0 basis) in exchange for 150k and
Newco’s assumption of 100k of A’s AP which would have been deductible under
§162(a) if paid by A
§357(c)(1) A would recognize 50k gain (excess of 100k AP over 50k cash)
§357(c)(3) AP are not treated as liabilities, A thus recognizes no gain.
A’s basis in stock is 50k and it is not reduced by AP assumed by newco.
Example 2:
Newco is formed, B, an accrual basis TP, transfers contaminated land w/ associated
contingent env. Liabilities in exchange for all of Newco’s stock.
B neither deducted nor capitalized any amount with respect to liabilities
The liabilities assumed by Newco in the exchange are not liabilities under §357(c)(1) and
§358(d) because NEVER DEDCUTED by B and they did not create or increase the basis
of property prior to transfer
Page 102
(a) Assuming that §357(b), is not applicable how much gain does A recognize and what
is A’s basis and holding period of the stock?
AB is 40k (aggregate 20k + 20k) and Debt assumed is 30k. So here there is no excess
No gain or loss is recognized when debt is assumed; it reduces the basis in stock received
AB in stock received is:
AB – 40k
(-) FMV of boot- Debt- 30k
(+)gain recognized = here none
So total is 10k basis.
Inventory No tack on and it is 50/50 split.
You get a tack on where a capital asset or 1231 asset. Inventory not included.
So each share you get back there is a split holding period.
Ie inventory – each share is 10k = so ten shares for inventory
Land – each share is 10k = so ten shares for land
Corp takes - basis of property transferred. Ie 20k and 20k
Problem 2:
B organized Y corp. and x-ferred bldg. with AB of 100k and FMV of 400k. Bldg. is
subject to mtg. of 80k which was incurred two years ago for valid business reasons.
B borrowed 10k for personal purposes with a secured loan on mortgage (this debt is
taxable)
Y corp will issue 310k of common stock to B and will take bldg. subject to mortgages.
(a) What are the tax consequences to B on x-fer of bldg to Y corp.
Step 1: Liability is 90k which is less than AB
(2) Is there a tax avoidance purpose so here yes the 10k, under regall liabilities will
be treated as boot!
AR here is 400k and AB is 100k so the lesser of 300k gain and boot is 90, so
recognize gain of 90k
Basis in stock is: 100k -90+90 100k Basis
(b) What if B did not borrow 10k and instead Y borrowed 10k from a bank and gave B
310k of Y c.s., 10k cash and will take the bldg. subject to the 80k mortgage
Now the 80k is not boot, but there is boot of 10k
10k boot is recognized gain
Basis- 100k -90+10 20k basis in stock
(c) Is the difference justified
In A, it was tax avoidance so that is why it was treated as boot.
(d) When might there be a leg. reason for corp to assume a property’s debt?
Bona fide business purposes.
SPECIAL PROBLEMS
Rev Rul-95-74
Key Notes:
General Rule of 357(c) Liabilities assumed (100k) – AB (60k) = 40k. However, AP is
not a liability whose payment by transferor would have given rise to a deduction/is not a
liability for §357(c) purposes (if architect paid them they would be deductible as a
business expense). So never use AP to increase the basis. Thus liabilities assumed is 30k
not 100k and thus basis is not > than liabilities assumed.
AB = AB=(60) – liabilities (30K) – gain (0) = 30k
What about the toxic liabilities.
Rev Rule 95-74- Contingent liabilities whose payment have been deduct do not increase
basis and not under §357(c)
So: do not use AP or contingent liability to calculate boot and AB of Transferor.
(b) Tax of AR that hasn’t been paid yet and is transferred is tax to the receiving
corporation
(c) For contingent liabilities the rule is:
Deductible by the corp., as a business expense under §162 or are capital expense under
§263 as appropriate under S’s method of accounting determined as if S has owned the
land for the period and in the same manner as it was owned by the P.
Reasoning for 357 © TP would get an offsetting deduction from the AR and AP but this
would not happen.
AB in Transferred Prop = 60
(-) FMV of boot = (30)
(+) any gain recog= 0
total = 30
Basis for corp = no gain recognized so will take basis that TP transferred.
the liabilities may be capitalized – part of the cost of the underlying capital asset (the land
that is polutted)
95-74 Rev. Rul = see above
Should tax benefit rule (recovery of money from previous deduction (ie supplies) from
sale be applied to a 351 - NO
(b) Who pays the Receivables – from hempt bros case. See above.
(c) Can AP once paid by Design be deducted as an expense – YES design can.
(d) TP is trying to mismatch revenue and expense. – TP wants to deduct the expenses to
reduce his tax And allocate all the income to the Corp. TP would have to incur the
income.
What happens when a shareholder loans to the company. Is repayment of the loan a
dividend payment or loan repayment.?
1. Debt equity test – compare the debt of sh with SH equity 1:1. Or 9:1 lenders
prefer to lend to the former. Because it signifies how much a biz can lose but pay its
debts. The second number in the ratio is called the equity cushion. Amount that can be
lost and pay the outstanding debt.
As opposed to
Stock Debt
A 300 1000
B 500 0
C 200 0
P. 1554-157 1244 stock for small corps - if sell stock at a profit get cap gain if lose
money can treat loss as ord deduction but limited to 50k (100k per married couple) per
year.
Character of Loss on Corporate Investment:
Stock and debt instruments are capital assets, any loss on their sale or exchange is a
capital loss
(a) Analysis:
(1) Determine the amount of the distribution under §301(b)
(2) How much of that is a dividend under §316
(3) Specific tax treatment of those amounts provided in §301(c)
Determining E&P
§312- effect of various transactions on E&P
E&P are determined by starting with TI and making Adjustments
E&P Formula:
Taxable Income Starting Point
(+) Items Excluded from taxable Income must be added back
Such as municipal bond interest, life insurance proceeds and fed tax refunds §1.312-6(b)
(+) Add Back Certain Tax-Deductible Items
§243 dividend received deduction
Remember 70% and 80% deduction, gets added back in (happens because of
subsidiary/parent relationship)
§243 dividends rec’d deduction – a deduction where a company that pays dividend to
another corp that ends up paying divident to ultimate shareholder. (the second co gets the
deduction).
(-) Subtract Non-Deductible Items
Fed tax paid
Capital Loss Carryovers you can only deduct to extent of capital gain for tax purpose,
so anything in excess should be used to reduce for E&P
Remember Carryovers from prior years cannot be subtracted b/c you took it once in the
prior year.
(+/-) Timing Adjustments (such as depreciation)
RJ said he probably won’t test on this.
Cash Distributions
Cash Distributions are dividends to the extent they are made out of current or
accumulated E&P §316(a) and §1.316-2(a)
C) 10k accumulated EP. 4k current EP on July 1 sells ½ her stock to baker for 15k on
April 1 distributes 10k and then on Oct 1 distributes 5k to ann and 5k to baker.
Total distributions for the year = 20k
Answer: allocate the 4k among the distributions.
Property Distributions
Consequences to the Corp:
(a) Background:
General Utilities
SC held that a corp. did not recognize a gain on a distribution of appreciated property to a
SH even though the SH took a FMV basis in the distributed asset.
§311(a) only applies to nonliquidating distribution of loss property
§311(b) Applies to appreciated property
Constructive Dividends
Transaction may not be labled as a dividend, but may be treated as constructive dividends
if there is an economic benefit to the SH.
Ex:
Unreasonable comp
Low-interest loans
Bargain sale or bargain leases
Payment of SH personal expenses
Excessive payment to SH for purchase of corp. property
Transfers b/t commonly controlled corp.
Case: D’Agostino No E&P and thus no dividend
Appellants, who were owners of two corporations, were convicted of conspiracy to
defraud the United States and tax evasion under HYPERLINK
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zSkAW&_md5=bcfb998700538ee7faaae76f70e9966d" µ18 U.S.C.S. �� 2§,
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However, on appeal, the court reversed and remanded the convictions holding that the
corporate funds, which appellants had diverted, were not taxable.
The court further held that under the no earnings and profits, no income rule, because
appellants’ corporation had not realized profits during the applicable tax years, the
diverted funds were received as the repayment of a loan from appellants to the
corporation.
Case- Boulware: “intent of parties”
The question was whether a 41istribute accused of criminal tax evasion could claim
return-of-capital treatment without producing evidence that either he or the corporation
intended a capital return when the distribution occurred.
Language of HYPERLINK "https://www.lexis.com/research/buttonTFLink?
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consequences of a distribution by a corporation with respect to stock depended on
whether the corporation had earnings and profits and the amount of the taxpayer’s basis
for his stock. The lower court’s view also created a tax limbo or forced resort to an
atextual stopgap as the interpretation created a disconnect between civil and criminal
liability.
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consequences of constructive distributions made by a corporation to a shareholder with
respect to its stock.
A defendant in a criminal tax case did not need to show a contemporaneous intent to
treat diversions as returns of capital before relying on those sections to demonstrate no
taxes were owed.
Smaill family co. purchased a yacht for the child non voting shareholder to use. The
IRS tried to tax the father voting sh (a constructive dividend). Ct said – bc father was able
to confer benefit to son thus he controlled the direction of the funds and thus should be
taxed on the dividend. The amount of the dividend was the cost of the yacht. The corp
held the title of the boat. Herbert was taxed on 75% of the daily rental rate.
Personal Benefit to SH
Corporate payments of expenses (meals, travel, entertainment) that provide only an
incidental benefit to the business and are primarily for the personal benefit of the SH or
his family may be classified as constructive dividends.
Ex: Nichols 75% personal use of corp., yacht was constructive dividend, to extent of
75% of yacht Fiar rental value
Rev Ruling 69-630
§482- authority to distribute, apportion, or allocate GI, deductions and credits among
related org., trades or bus., if it is necessary in order to clearly reflect the income of such
entites or to prevent the evasion of taxes
§482- bargain sail transaction b/t bro-sis corp that result in shifting of income
Amount of allocation will be treated as a distribution of the controlling SH, with respect
to the stock of the entity whose income is increased and as a capital contribution by the
controlling SH, to the other entity involved gives rise to §482
Issue- A owns 100% X and 100% Y. A caused X to sell its property to Y for less than
arm’s length FMV price. Assume FMV for 100 sold for 80.
X’s income was understated b/c avoidance of income.
X will increase income to reflect arm’s length price of the property sold to Y
Basis of Y will reflect arm’s lentgth price.
Amount of such increase will be treated as a distribution ot A< with respect to his stock
of X and capital contribution by A to Y
Thus X income increases by 20 (as though sold for FMV) and thus Y basis increase by 20
(paid FMV)
To bring this inline with economic reality - the $20 is treated as distributed as Corp dist.
(301 could be ) to A. and then A made a capital contribution of 20 to Y corp. increasing
A’s basis in the Y corp
Using of Dividends in Bootstrap Sales see TSN Liquidating case.
A parent corp., that is about to sell stock of a sub in a taxable transaction may attempt to
convert capital gain on the sale to dividend income by causing the sub to make a large
distribution shortly prior to the acquisition
Success depends on time of the distribution and source of the distributed money
Ex:
X owns all the stock of T which has a value of 1m
X’s basis in the stock is 200k
T has ample E&P
P wishes to purchase the Stock
If X sells its T stock to P for 1m cash, X realizes 800k of gain taxable at 35k
If X causes T to distribute 800 to X and the entire amount is a dividend, X may deduct
100% under §243(a) and realizes no gain on the sale of the stock for 200k
If, after neg. began for the sale of T, the distribution were paid in the form of a T
promissory note that was later paid off with funds supplied by P, it likely will be
reclassified as a payment of the purchase price.
If T distributed its own excess liqudi assets, dividend will likely not be reclassified even
if the buyer infuses T with liquid assets shortly after the purchase.
Caveat- Strategy may not be viable if X and T file a consolidated return of if distribution
to X is extraordinary dividend under 1059.
Waterman Case disposition was a dividend- IRS said waterman was different from here,
bc UM reinfused the CLIC with assets same as a beginning. Ct disagreed.
Facts of waterman –
Waterman owned PA with a FMV of 3.5
Securities wanted to buy
Securities lent PA 2.8 million dollars and satisfied the note to waterman.
Ct said it was part of the purchase price. Securities was using Pan atlantic as a conduit to
transfer cash to Waterman.
It differs from TSN bc in TSM the targets assets changed substantially.
PA did not
Chapter 5- Redemptions and Partial Liquidations:
A. Introduction
§302(c)(1)
§318
§1.318-1(a), (b)
§1.318-2
§1.318-3(a), (b)
§1.318-4
(1) Generally:
An individual or entity is treated as owning stock owned by certain related family
members, corporations, partnerships, estates and trusts under the attribution rules in §318.
(for §302 purposes) §302(e)(1)
Rationale- related individuals and entities have a unity of economic interest.
Ex 1- A, B and C are equal partners in ABC Partnership. The partnership owns 120
shares of X corp. stock. A,B, and C each are considered to own 40 shares of X.
(b) Trusts
§318(a)(2)(B)(i)
Stock owned by a trust (not qualified employee retirement plan) is considered owned by
its beneficiaries in proportion to their ACTUARIAL interests in the trust, however small
or remote.
§318(a)(2)(B)(ii)
Stock owned by a grantor trust is considered as owned by the person who is taxable on
the income of the trust
Example:
Trust owns 100 shares of X corp. A is the income beneficiary of the trust and B is the
remainder person. A and B’s actuarial interests are 60% and 40% collectively. So A owns
60 shares and B owns 40 shares of X corp.
(b) To Trusts
All stock owned by a trust beneficiary is attributed to the trust unless the beneficiary’s
interest is both remote and contingent.
Remote 5% or less of the value of the trust property, assuming the trustee will exercise
minimum discretion in favor of the beneficiary. §318(a)(3)(B)(i).
§318(a)(3)(B)(i)- Grantor trusts are considered as owing stock owned by the grantor or
other person taxable on the trusts income.
Example:
A is the income beneficiary of Trust. A owns 100 shares of X corp., all of which is
considered owned by the trust. If A had only a contingent remainder which was 5% or
less of trust property, none of A’s shares would be attributed to the trust
(c)To Corporations
All stock owned by a SH who actually and constructively owns 50% or more of a corp.’s
stock is attributed to the corporation§318(a)(3)(C)
Ex: A owns 60% (by value) of X corp. stock. A owns 100 shares of Y corp. X corp., is
considered to own 100 shares of Y corp. from A.
If A owned less than 50% of X, however, none of A’s shares in Y would be attributed to
X.
(a) Reattribution
Stock constructively owned by a person under §318 is considered as actually owned for
purposes of reattribution that stock to another person.
Example:
A and B (unrelated) each own 50 of the 100 o/s shares of X.
X owns 100 shares of Y corp.
A is 50% partner in the AC partnership
B is the sole beneficiary of Trust
A and B each is considered as owning 50 shares of Y through .
A’s shares of Y are reattributed to AC partnership and B’s shares are reattributed to the
trust
Partnership and Trust each is deemed to own 50 shares of X directly from A and B
respectively.
Mothers daughter
Own share 15
Mother 20
Mothers share of gm estate 15
Mothers option to purchase son shares 5
Total = 55
GM estate
Own share 30
Attribution from mother (bc beneficiary) 20 + GF (25) + 15 + 10 =
Total 100 = all the shares.
Mothers
(2)
All of the 100 Shares of X corp. are owned by a partnership, in which A,B,C,D are equal
partners . W, A’s wife, owns all of the 100 shares of Y corp.
(a) How many share, of X corp. are owned by A, W and M (W’s Mom)
A owns
Own shares 25 (100 shares * .25)
W owns
Her husbands shares 25 shares
M owns
Nothing
(b) How many shares if any of X are owned by Y? Would Y constructively own any
shares of X if W owned only 10% of Y
Y owns
Flow from A to wife to Y. = 25 shares.
If W owned 10%
Flows from A to wife. But bc not 50% or more there is no flow to Y. = 0
(c) How many shares, if any, of Y are owned by B,C,D, and X?
Partnership =
Wife owns 100 shares
A constructively owns 100 through family.
All of those are attributed to Partnership
BCD
Wife owns 100
A constructively owns 100
Then go to Partnership
But bc of anti sidewise – those don’t get attributed to BCD
X
Wife owns 100
A owns 100 constructively
P owns bc a partner
Then it is attributed to X bc P is a beneficial owner of X. = 100.
(2) Z Corp has 100 shares of voting CS and 200 shares of nonvoting CS. Every share of
ZCS has a FMV of 100. D owns 60 shares of Z voting CS, and 100 of Nonvoting CS..
J owns all the remaining stock of Z40 Voting, and 100 Non voting. D and J are not
related. If Z redeems 30 of Don’s voting CS (now Don will have 30)¸will redemption
qualify under §302(b)(2) for exchange treatment?
D- 60 Voting and 100 Nonvoting (60%)
J- 40 Voting and 100 Non Voting
Common Stock- 100 and 200 Non Voting
D- Before 60% or 48% or less or step (2)
D- After 30/7042.9%
Step 1 <50%
Step 2 <48%
Step 3 Common Stock FMV is 100 per share
CS Before 300 x 10030k
Don owned 160 x10016k which is 16/3053.3 * .842 2/3 %
Don After 130x10013k and CS after is 270 x 100k27k which is 48.1%
This is not less than 42.3% so this step fails to qualify.
In General
A redemption that completely terminates a SH actual and constructive interest in the
corporation will be treated as an exchange under §302(b)(3).
If a corp. distributes its debt obligations in exchange for the redeemed stock the SH may
recover the stock if Corp defaults, and IRS may contend that SH has not terminated their
equity interest.
(a) Waiver of Family Attribution
§302(c)(2) A redemption that completely terminates a SH actual interest in a
corporation will be treated as an exchange even if the SH (called the distributee in
§302(c) constructively owns stock of a family member under §318(a)(1) provided
following requirements for waiver of family attribution in §302(c)(2) are met
(1) All Interests are Terminated
§302(c)(2)(A)(i)
Distributee may have no interest in the corporation as a SH, officer, director or employee,
immediately after the distribution.
Case: Lynch v. Commissioner:
Parents wanted to turn co over to son.
Corp sold 50 shares to son (16k was a gift)
Corp redeemed stock in form of prop and a note
Son needed help .. father was kept as a consultant.
9th Circuit Ct held that a TP who performs post-redemption services for the corp. as an
independent contractor retains a prohibited interest.
Father was only engaged for limited purpose and he did not have a financial interest in
the corporation.
Two Prong Analysis by tax court
1. Whether there is a significant financial stake or
2. Did he retain control of the company
Tax court held that F did not have a continuing interest in the corp., and no financial
stake (500/month fee) thus waiver was satisfied.
9th circuit/holdingCongress wanted to establish a bright line test. - see above.
Hypo: What if you perform tax services, does this have an interest (under Lynch yes)
Hypo: Father owns a filling station and trucks stop and get their tanks filled. Is this a
continuing interest in the corporation so that it disqualifies a waiver of family attribution
rules. Jensen says no, he thinks 9th circuit approach is not good.
Employee vs. Independent K Employer has right to determine rights of employee and
not the independent K. Independent K performs limited functions for the partnership.
§1.302-4(d) the retention or acquisition of an interest as a creditor is permitted. A
person is considered to be a creditor only if her rights are not greater or broader in scope
than necessary for enforcement of the claim.
(2) Ten-Year-Look Forward Rule
The distributee may not acquire any of the forbidden interests (other than stock acquired
by bequest or inheritance) during the 10 year period beg. The date of the distribution in
redemption. §302(c)(2)(A)(ii).
§.1302-4(e) Distributee who remains a creditor of the corporation after a redemption is
not considered as acquiring a prohibited interest by acquiring corporate assets to enforce
her rights as a creditor, but an acquisition of stock is prohibited.
(3),Procedural Requirement
§302(c)(2)(A)(iii)- Distrubutee must attach a statement to her income tax return for the
year of the redemption reciting that she has not acquired any prohibited interest since the
distribution and agreeing to notify the service of any such acquisition w/in 30 days after it
occurs during the 10 year-look forward period and to extend the SOL for assessing and
collecting a tax with respect to the distribution on year after the notice
§1.302-4(a)(2)- IRS may grant extensions for filing the agreement if TP shows
“reasonable cause” for a late filing.
(4) Ten Year Look Back RuleEXCEPTION
(1) Distributee must not have acquired any portion of the redeemed stock w/in the 10
year period preceding the distribution from a person who stock is attributable to the
distrbutee under the family attribution rule in §318(a)(1)
(2) At time of distribution, no person may own stock which is attributable to the
distrbutee under the family attribution rules if that related family member acquired any
stock in the corporation from the distribute within the 10-year-look-back period.
DOES NOT APPLY IF:
§302(c)(2)(B)- Acquisition or disposition by the distribute during the 10 year look back
period was not principally motivated by a tax avoidance purpose.
§1.302-4(g)- A gift of stock is not principally motivated by tax avoidance merely because
the donees is in a lower income tax bracket.
Example:
Parent and child own 50 of the 100 o/s shares of X Corp.
Parent, who wishes to retire and shift control of X to child, makes a gift of 20 shares to
child and X corp. redeems parent’s other 30 shares, leaving child as the sole SH.
Parent retains no other interest in X Corp.
Here: Tax avoidance was not one of the principal purposes of the transfer to child, and
the 10 year look back rule will not prevent the redemption form qualifying for waiver of
family attribution under §302(c)Rev Rule 77-293.
Page 235
Corp owned by J, daughter, and son. John owns 100, daughter 50 son 25
A) before owns 100% after owns 100% redeems 50 shares. Would qualify as an
exchange if waived the family attribution rules.
B) if didn’t file agreement not to notify IRS – then not eligble for exchange treatment
C) what if shares contignent on R’s future profits ? this is some financial interest – regs
say specifically that this is a prohibited interest (§1.302-4(d))
D) R redeems 20 of alisons shares in year one; and remaining 30 shares on year two.
Here could argue that this was part of a single transaction. – substance over form.
Test - yr 2 redemption would have to be fixed and determined at the time of the
initial transaction.
E) randall remains a director – this is a prohibited interest
F) R forms a subsidiary and Alison becomes an employee of the sub. – this is a
prohibited interest (§1.302-4(c))
G) son dies and leaves Alison shares. – here she regains interest within 10 years – this is
allowed. (gain by bequest or inheritence)
A) is it an exchange?
Son received interest prior to redemption this would not qualify. But this is as valid
business purpose. See 77-293
The note paid to parents for redemption lasts 20 year period. - a long term note – is
more like equity – is more risky. However, Cts have allowed debt instruments to qualify.
Agreement to restrict dividends and such other – Code says – can continue as a creditor
– is it unusual to put a restriction No creditors often do this.
The lease? Redeemed SH can enter into an arms length lease with co.
B) B creates a consulting firm. And wants to consult for B&B – lynch says no. there is no
Ind Contracter relationship permitted.
Tax ct; would use test;
1. Whether there is a significant financial stake or
2. Did he retain control of the company
3. Cinelab 100 shares outstanding. J owns 50 sister owns 30 estate of father owns 20.
Sams widow is beneificiary
(a) cinelab redeems estates 20 shares . – bella owns J and M shares and estate owns all
shares.
Before = actually own 20% const 80%
After = actual non- const 100% - so there is a problem – a complete redemption
can be waived where family attribution rule applied. See waiver by entity below.
Estate must agree to have no interest in co. bc of 302©2© bella must also agree to all 3
provisions.
(b) J and M have specific legatees and B has residuary Here bc J and M have attribution
through beneficial ownership. The estate can only waive family attribution and not
beneficial owner
© J and M are residuary beneficiaries – here to solve the problem would typically pay J
and M their interest but.. they are residuary benes and thus cant pay off.
(d)20 shares owned by a trust providing income to bella and remainder to nancy. The
trust can waive the attribution through family attribution.
Nancy is a sibling and there is no family attribution concerns between siblings.
(1)Z corp has 100 shares of C/S o/s owned by A (28 shares) B (25 shares), C (23) and
D(24).
Unless o/w indicated, assume no relation. Determine whether the redemption is not
essentially equivalent to a dividend?
(a) Z redeems 7 shares from A – A yes there is a meaningful control change – before he
could ask only one person to form a majority. Now he has to ask two to form a majority.
Make sure to consider majority by the reduced
(b) X redeem 5 shares from A and A and D are mom and daughter. Before comblinec
control of 52% now 49.47% - this is a meaningful reduction
(c) Z redeems 5 from A and A and B are mom and daughter A and B together still have a
majority and not meaningful
(d)Same as (c) except that A has not spoken to B since B married “o/s faith” . there are
approaches. ... IRS does not care about family disputes. Other cases say.. if there is a
slight reduction in interest then can consider all facts and circumstances.
(2) Y corp. has 100 shares of C/S and 100 shares of nonvoting preferred o/s stock. The
p/s is not convertible into Y C/S and is not §306 stock. The Y common and P/s are owned
by the following unrelated SH
SHCommon SharesPreferred SharesA400B2055C2510D1515E020
a) Y redeems 5 preferred shares from E
this is redemption not equivalent to a dividend – no meaning ful control change
b) Y redeems all of its outstaning preferred stock.
For E its an exchange.
For the other sh’s – if sh can control corp with help of small number of other sh’s then
IRS only focuses on power to control.
Here bcd can control the corp by colluding with a – here it would not qualify as an
exchange.
(3) Indv. Owns 10 shares of CS with AB of 15k. 5 shares are redeemed in a transaction
that is a dividend. What if 10 are redeemed which is properly classified as a dividend
because §302(c)(2) waiver of family attribution is not available?
A receives a dividend.
Here the basis transferes from the 5 shares redeemed to the 5 shares that remain.
Bc it is a dividend and will be paying tax on it as ordinary income.
What if all ten shares are redeemed (thus no shares left) . it is still taxed as a dividend
bc he was unable to waive the family attribution rules.
The Basis passes to the shares that he is deemed to own by construction.
Occurs when a corp., significantly contracts its business and makes related distribution
(of assets or their sale or insurance proceeds) to its SH in redemption of all or part of their
stock.
When distributions in redemption results from such a “corporate contraction” the
transaction is more like a sale than a dividend.
§302(b)(4)- exchange treatment for distributions in redemption of stocked held by
noncorporate SH if the transaction is a “partial liquidation under 302(e) of the
distributing corporation
§302(b)(4) looks on the nature of the assets distributed and the corp’s reason for making
the distribution. (other tests look to the effect of a redemption on the distribute SH)
Corporate Contraction Doctrine (amorphous and cannot be relied upon w/ assurance for
planning)
A distribution in partial liquidation is not essentially equivalent to a dividend if it result
from a (permenant) contraction of the corporation’s business such as:
(1) Involuntary Events
After a fire damages a manufacturer’s factory, co., distributes the insurance proceeds and
contracts its business operations. Imler v. Comm’r and reg 1.346-1
(2) Change in Nature of Business
A corporation distributes working capital that is no longer needed b/c of a change in the
scale of its operations
(3) reserve for Expansion
A corporation no longer needs funds that had been accumulated for expansion/ Reg
1.346-1
A corp operates a book and cram division. A’s single class of c/s O/S are owned in equal
shares by M, P (M’s wife) and I Corp. Neither M nor P own any stock in Iris. A also
owns all of the stock of Beta Corp, a separately incorp., company which is engaged in the
beta processing business, and it directly owns a diversified portfolio of securities
(a) A has operated B and C for more than five years and it distrubtes the assets of Books
to its 3 equal SH in redemption of 50 shares from each SH. Does result matter if there is
no actual redemption of shares - can qualify or exchange treatment under the safe
harbor provision under e2 a and b met. Does not apply to the corporation bc they cant
qualify for exchange treatment here – here it is a distribution under 301.
(b) A purchased Books three years ago for cash, if so why does that matter? What if A
acquired books 3 years ago in a tax free re-org?
bc it was purchased within 5 year period with cash (someone recognized gain or loss)
if it acquired in a tax free organization – will get exchange treatment under the safe
harbor as long as it operated for 5 years prior.
(c) All assets of books were destroyed by fire and A distributes ½ of the insurance
proceeds equally to its 3 SH in redemption of an appropriate number of shares of stock
and retains the remaining proceeds to carry on its book publishing business on a
somewhat smaller scale
won’t qualify under the safe harbor. (not distributing all the assets i.e. the insurance)
Might qualify under imler if it is a permanent reduction of the business.
(d) Same as (a) except A distributes assets of Books to Michael in redemption of all stock
can qualify as an exchange under the safe harbor.
(e) Same as (a) except A distributes the assets of Books to Iris for all of A’s stocks
does not qualify as a partial liquidation bc it was a corp
may qualify as a complete termination of interest. – and get exchange treatment
(f) A distributes the securities portfolio to its 3 equal SH in redemption of 20 shares from
each SH
(g) A sells all of its Beta stock and distributes the proceed pro rata to SH in redemption of
20 shares from each
not a partial liquidation – selling a subsidiary does not qualify under the safe harbor –
beta is an investment and thus is not a qualified business and not ceasing to conduct a
business.
(h) Same as 9(g), except that A liquidates B and then distributes the assets of B’s
business which has been operated more than 5 years.
Will qualify under the safe harbor
D. Specific Tax Consequences of Redemptions
(1) Consequences to SH
(a) Exchange:
If redemption is treated as an exchange, the distributee SH computes gain or loss as if the
redeemed stock had been sold to an o/s.
In case of losses- §267(a)(1)- disallows a deduction if the redeemed SH owns
(directly/indirectly) more than 50% of the corp. stock.
(d) Corp. SH
§243 dividends received deduction
(1) Bootstrapping
Zenz v. Quinlivan
If a redemption and sale are part of an integrated transaction to dispose of a SH entire
interest in the corporation, the redemption will qualify as a complete termination under
§302(b)(3) whether it occurs before or after the sale.
SH use this to remove liquid assets from a corp and sell the remaining stock at a reduced
price known as a bootstrap
Rev Rule 75-447
A sale and redemption also may be combined to qualify the redemption as “substantially
disproportionate” under §302(b)(2).
Ex 1:
A owns 100 o/s shares of X. The value of X is 100k including 20k in cash a nd 80k
operating assets
X has 50k of E&_.
B wishes to by X for 80k.
X first distributes 20k to A in redemption of 20 shares. A sells remaining 80 for 80k to B.
If the redemption and sale are part of an integrated plan, A is considered to have
completely terminated interest in X and exchange under §302(b)(3)
Ex 2:
A and B are unrelated and each own 50 of X’s 100 o/s shares
C also unrelated wants to come in business, X issues 25 c/s to C and pursuant to the same
plan redeems 25 shares of its stock from A and B. So now 25 each out of 75 ps/
A and B’s interests are reduced from 50% to 33.5 and thus, this a substantially
disproportionate under §302(b)(2)
(b) Constructive-Dividend
Problems arise when a continuing SH is personally and unconditionally obligated to
purchase stock pursuant to a buy/sell agreement and that obligation is assumed by the
corporation. Sullivan
A mere assignment to the corp of an option to purchase stock from another SH is not a
constructive dividend, Holsey.
Ex 1:
A and B, who are unrelated, own all 100 shares of X
A and B agree upon the death of either SH, the survivor will be unconditionally obligated
to purchase decedent’s X stock from his state
B dies, A causes the corp to assume his obligation and redeem the stock from B.
Redemption is a constructive distributon to A Rev Rule 69-608
Ex 2:
Same as (1) but agreement provides that upon the death of either SH, X corp., has an
option to purchase the decedent’s stock.
If X chooses not to exercise the option, Survivng SH is obligated to purchase any
redeemed shares.
If B dies and X redeems all of B’s stock, the redemption is not constructive toA, because
A was not primarily obligated to buy the stock. Rev Rule 69-608
Ex 3:
Now, agreement says either SH has an option to purchase stock of other b/c of certain
events but is free to assign the options ot others.
At B’s retirement, A ssigns his option to X corp., which redeems all of B’s stocks.
Redemption is not constructive to A b/c A had no unconditional obligation to buy the
stock Rev Rule 69-608
Problem
Introduction
Policy
§304 prevents a SH from selling stock of one corp to another related corp in order to w/d
(bail out) earnings while treating the transaction as a sale rather than a dividend.
§304 applies when one or more controlling SH sell stock of one corp., to another
controlled corp (“brother-sister acquisition) or when any SH of a parent corp sells stock
of the parent to a sub (parent-sub)
§304 looks for dividend equivalency by applying §302 to determine if SH has sufficiently
reduced his interest in the corp., whose stock has been transferred
Example
A owns all stock of X and Y, each who have a lot of E&P.
If either corp were to redeem shares held by A, distribution would be a dividend.
If A sells or part of her X stock to Y, the effect of the transaction is the same as a
dividend b/c A has w/d funds from Y w/o reducing her 100% control of corp
§304 Definitions:
Property
§304 applies only to acquisitions of stock in return for “property”
“property- money securities, and other property but not stock, in the corporation making
the acquisition.
Acquiring Corporation
Corp that acquires stock form a SH of another related corp., in return for property
Issuing Corporation
Corp whose stock has been transferred.
Control
(1) Ownership of stock possession at least 50% of the total combined voting power of all
classes of stock entitled to vote, or¸ 50% of the total value of shares of all classes of
stock §304(c)(1)
§318 attribution applies. §304(c)(3)
Mode Analysis
(2) Does the constructive dividend qualify under §302 as a redemption determine if its a
Calculate amount of stock before in corporation
Calculate amount of stock in corp (remember to multiply %)
ex. (treated as A transferring the stock to Acquiring co in a 351 trans. Getting stock back.
A’s basis is the same as the basis in transferred asset; corps basis is the b transferred basis
of the stock)
Constructive Redemption
If one or more persons are in “control” of each of 2 corp nad sell stock of 1 corp to the
other corp., in retrun for property, property is treated for purpose of §302 and §303 as a
distributuion in redemption of the stock of the acquiring corp. §304(a)(1)
§304(a)(1)- 2 or more unlreated SH who in the agg. Control each of the 2 corp., sell stock
of one corp., to the other in related transaction even if no SH has control
§304(a)(1)(B)
Tax Consequences:
1) §301 Distribution
If under §301, look at E&P of acquiring corp., then E&P of issuing corp. §304(b)(2)
2) Exchange
SH recognizes a gain or loss measured by the difference b/t the AR and the AB in the
transferred stock
SH basis in the stock remains unchanged and acquiring corp takes a §1012 cost basis in
the issuing corp’s stock §1.304-2(a)
E&P reduction I limited by §312(n)(7) to an amount not in excess of redeemd stock’s
ratable shares of E&P.
Ex 1:
Ex 1:
A&B (unrelated) own 100 of the 200 shares of X corp and Y corp. respectively
X has 70K E&P, and Y has 40k E&P.
A sells 30 shares of X corp with AB of 10k to Y for 100k
Does this qualify under §304:
(1) A owns at least 50% of all classes YES! So §304 applies
(2) Before transfer A’s shares in issuing corp (X)- 50%
(3) After transfer A’s shares in issuing corp (X)- 70+1585/200- 42.5
(4) No change under §302 (need to analyze each, so comes under §301)
(5) §301 dividend treatment, so it will be 10k coming out of Y (Acquiring corp.) E&P.
(6)
(a) §351
§304(b)(3)(A)- §351 will not apply to any property received in a §304(a) distribution,
except that §304 will not apply to any debt incurred or assumed in connecton with the
acquisition of the transferred stock. §304(b)(3)(B)
Ex (1)
A owns 80/100 o/s shares of X corp. and Y corp
Both have E&)P
The remaining stock is owend by unrelated SH
A sells 20 shares of X (AB-4k, value 15k) to U for 15 shares (15k) and 5k cash
Transfer qualifies under §351 for the stock but §304 applies for the cash
Ex (2):
Same as above, except A transfer 20 shares of X to Y for 15 shares and a liability
incurred by A when he acquired X
A recognizes now gain under §351 and §357, and §304 does not apply to Y’s assumption
of liability.
(1) The Niedermeyer case is a good example of tax planning blunder. Illustrates the need
for §304
(a) Why did §304 apply to the sale by the TP of their AT&T common stock to Lents
(b) Given that §304 applied, how do you test the redemption to determine if the TP have
a dividend
(c) Why were the TP unable to waive family attribution and qualify for “sale” treatment
under §302(b)(3) – did not have complete termination of their interest.
(d) How could they have avoided this unfortunate result - if they had donated the
preferred shares before the transaction they could have waived the family attribtion rules
and thus would not have cnstructively owned AT and T
TP argued that it was a dividend not equivalent to - saying there was family animosity
- ct said should never consider family animosity
- txct says that if there is any reduction in ownership then can consider
TP argued that the PS was actually debt – this argument fails
TP can only integrate two tax transactions where there was a fixed and firm intent to
complete the second transaction,
(2) - P. 299
Bail corp. and Out corp each have 100 share of Common stock O/S.
Claude owns 80 share of Bail stock (AB of 40k or 500 per share) nad 60 shares of Out
stock (AB of 9k or 150/share)
Remaining B&O shares are owned by 1 individual who is not related to Claud
Bail hs no current or Accumulated E&P.
Out has no current and 5k of accumulated E&P
(a) Claude sells 20 of his out shares, in which he has 3k AB, to Bail for 4k – 304 governs
because claude owns 50% of the control of each.
- therefore it is a constructive redemption
is it a 301 or is it an exchange
do a before or after analysis
before – 60% before after – Actual 40 + constructive 16% (80% of 20%) = 56% ( does nt
satisfy substantial (not less than 50%) not dividend equal and went from 60% to 56%
thus its not an exchange
4k dividend results = Accumulated E & P is reduced from 5k to 1k Claudes basis is
increased by 3k in bail. And bails basis is 3k in the transferred shares.
(c) Same as (a), except that C receives 3k and 1 share of Bail (FMV of 1k) for his 20 of
out shares
this would qualify under 351 and 304 – in these circumstances 304 governs
transfer of prop in addition of stock
receive in exchange stock
(d) same as (a) except that Clreceives one share and 3k in liability. 304 still governs.
304b3b situation not governed by 304 if liability incurred to acquire the stock. (see
page 291-292)
immediately after must control (ie 80%) - tax consequences - got boot - tax the lesser of
the realized gain (AR 4k – AB 3k = 1k) or the boot ( 3k) thus taxed on 1k its also capital
gain.
However – t304 says the boot requires treatment as dividend.
(2) §304 still necessary
(1)Introduction
(a) Types of Stock Distributions:
Corp makes a stock distribution when it distributes its own stock to some or all of its SH
Stock distributions include:
Stock dividends and Stock splits
Stock dividend may differ from a stock split
Stock Split- increasing number of o/s shares of the same class
Stock Dividend- smaller and may be of another class of stock (ex- preferred)
Hilll is organized into two classes of stock Frank owns 100 shares of Class A and Fay
and Joyce each own 50 shares of class B.
non taxable –
f) assume on one class common outstanding. Issue – 10% debentures –convertible into
common stock at 1 Cs:: $1000 debenture.
hill makes annual interest payment and one month later distribute common on common
stock dividend w/o adjusting the conversion ration of the debentures
g) same as f but the debentures are convertible preferred stock. Corp declares a one for
one split on the CS and the preferred ratio is doubled. –
this is non taxable – it’s a proportionate ratio
if short term – some would convert and some would not convert – causing a
disproportionate dist. – with long term --- there is no disproportionate dist.
2.
a has 500sh
b has 300sh
c has 200sh
z corp has one class of CS – will 305c3 if there is a redemption plan for a shares.
Before is a 50%/30%20%
Yr 1 After its 47.4%/31.6%/21.0%
This redemption is no longer meaningful. – and does not satisfy the 8% test. – 301
applies. And could treat it as a constructive stock dividend.
§306 STOCK
P. 330 – Corp non convert non vote PS worth 1k to J and V each had basis of 2k prior to
dist and avalue of 3k after. Corp. had E and P of 2k and Y3 E and P of 3k
a) in yr 1: distribution of PS is tax free (no gain or loss (305a)) and have to reallocate
basis after distribution from CS to CS and PS
AB of PS= FMV of New / FMV of OLD * old basis
1k/ 3k +1k = ¼ * 2k = 500 basis in pf and 1500 basis in
common.
No tax consequences to arg. – no reduction of e and p
b) V sells PS to Carl for 1k in year 3. There was 2k in E and P thus all 2k would be a
cash dist (dividend). she received 1k. J received the other 1k: AR on sale is Ord Income.
all 1k is taxed as OI – 15% dividend rate.
Problem is she had a basis in the PS of 500; this disappears and flows back into the
common. Thus the CS basis returns to 2000 (from 1500 after reallocation)
c) same as B but V sells to carl for 1750 – the first 1k is treated as OI (as above). the next
500 reduces basis in the PS to zero. The rest (250) is capital gain.
e) if J gives to grandson. Generally - GS gets the transferred basis (still 306) sells stock to
unrelated party. 306 does not apply in certain circumstances (see above) grandson does
not have attribution interest—it’s a complete termination of interest. GS sold stock to
unrelated party for 1000. Exceptions: 306b1 termination of sh interest not in redemption.
This is treated as a sale AR –AB = 1000-500 = Cap gain of 500.
306 does not apply in death bequeaths – the stock loses its 306 status. There is a step up
in basis to FMV at the time of death.
f) skip
g) see firoved handout – CS - before and after analysis before 50% after 33 1/3 % - is
this substantially disproportionate. – 1. Must have less than 50% and voting power must
be 80% of what it was before. Both satisfied. Thus is a substantially disproportionate
stock.
Redemption of 306 exception (and wont apply) – complete termination of interest or
partial liquidation. Does not occur here. Must argue that qualify under 306b4 see
fireoved. In fireoved – he maintained his same level of control (veto power) here
probably did not retain the same level of control after the redemption. Went from veto to
no veto. – should be able to get exchange treatment.
Corp distributes all of its assets (or proceeds of their sale) subject to any liabilities, to its
SH in exchange for all their stock
Corp then dissolves under state law.
§1.332-2(c)- Corp. liquidates for tax purposes when it ceases to be a going concern and
its activities are merely for the purpose of winding up its affairs, paying its debts and
distribution any remaining balance to SH
Corp sells to 3rd party assets to pay creditors and give cash to SH and to satisfy claims to
creditors and SH.
a) Corp will recognize a gain of 300k. and a loss of 400k. no disqualified property
distributed pro rata. And no distribution within 2 years ie net loss of 100k
b) this is not a pro rata distribution thus cant recognize the loss of 400k. thus there is a
gain of 300k
c) gainacre gain is 300k loss acre loss of 400k = just net the gain and loss 336d1 and
2 don’t apply 1. Not related 2. After 5 years.
What happens if 362(e) (2) did apply at the time property transferred to the corp. step
it down at the time of the transfer – result is the same.
F) if 362 e2 applied –
Ivan contributed gainacre and 362e2 applied - trying to reduce the aggregate
basis fro 900k aggregate to 800k aggregate. With respect to lossacre you reduce it to
700k reduce the aggregate basis to the aggregate fmv.
property – thus cant recognize loss of DQ prop to related person – only recognize a loss
of 60k by flo.
Subsidiary Liquidation
Viewed as a mere change in form – not a taxation event
80% total value of all stock – and 80% of the total voting power (BOTH)
§332 and §337 generally provide that neither the parent SH nor the liquidating corp
recognize gain or loss on the receipt of property in complete liquidation of an 80% or
more subsidiary.
Parent takes the distributed assets with a transferred basis under 334b1
Holding period also tacks on.
Sub asset bases and other tax attributes transfer to the parent
b)S gets no loss recognized for distribution of equip to I . no gain or loss recognized
to P
P does not recognize a gain or loss and takes a transferred basis. I takes a basis of 1k in
equipment
What could it do – sell the equipment and take the loss – if 336d2 applied however,
reduce the basis of the equipment to 1000. (sold in connection with a liquidation).
Reorg occurs where corp acquires stock of another corp for its own stock
Target
P= Parent/Purchaser
T merges into P
P survives
SH of T receive shares of P this is a tax free reorg 368.
Control is defined in 368c - 80% of voting power and 80% of all other stock
100% of SH receive stock but pursuant to preexisting agreement that sale of new stock
ocurred
is this a reorg.
acquiring corp must get substantially all the assets of the target
what is substantially all?
Gross assets – liabilities = net assets
It is substantially all if 70% of gross assets AND 90% of net assets.
You can have some boot in a C reorg – up to 20% can include boots – includes
assumed liabilities)
Target must dissolve.