Seminar: Taxation Current Issues
Chapter 18
Answer to question number 1:
Section 351 and part 1031 resemble each other in phrases of now not giving focus to loss and gain of particular transfers and thereby exempt from tax implications. The thinking of taxpayer’s consistency in investment defines the precept of now not attention of acquire or loss. The loss and obtain should be assigned to the real exchange of the economic repute of the taxpayer, which is why each these sections do now not recognize any reap or loss till significant changes happen. Therefore, both the sections are alike from these perspectives.
Answer to question variety 2:
As per the section 351, if the character who transfers, receives a boot (money or property not stock) in return to the transfer then gain is recognized. The gain is measured against the fair value of the boot. Based on the type of the asset transferred, the category of the boot is recognized. Importantly, a loss is never recognized.
Answer to question number 3:
A comprehensive definition of the property that includes both cash and fixed assets is in the core of the section 351. In addition to that a taxpayer’s receivable cash that remained unrealized, secret formulas and processes, and a penetrable inventory related secret information that is general in nature are considered to be property. One thing that is excluded from the section’s definition of property is the rendered service.
Answer to question number 4:
Any nonstock property that a shareholder receives from a corporation is termed by the word “boot”. Both Cash, Debt (like Bonds) or any other properties fall into the category of the boot. If a boot is obtained by a shareholder the loss will not be perceived in the transaction whereas in case of gain, the boot will be realized and recorded in the book at least in the form of any of the following:
- Actual amount of obtained boot
- Realized amount of gain.
However, if all conditions in the section 351 are not satisfied, then a gain cannot be recognized or recorded in the books of any of the parties i.e. the shareholder, or the corporation. In addition, both the basis of the shares is the same and equal, which implicates no alteration is taken place. On top of that, exchange is entirely taxable if the 80% control test is failed.
Answer to question number 5:
Since securities constitute boot under the section 351, its reception in exchange of the transfer of appreciated property to a controlled corporation cause recognition of gain.
Answer to question number 6:
The control requirement of section 351 is that the exchange will immediately hand over the control of the corporation to the property transferors. To ensure that the entity is a controlled corporation, the transferor should possess the 80% of the stock ownership of the corporation. The transferor need to possess stocks that give him 80% of total voting rights and 80% of shares of the entire property, including all classes of stocks. This requirement is often termed as an 80% control test.
Since stock in return to the rendered services cannot qualify as property as per section 351, any shareholder who render services to the corporation for stock can lose his control to other shareholders. For example, if a person “A” transfers property to the “X” corporation for 50% of the stock and if person “B” renders service to the same corporation for 50% of the stock then both the transactions will be taxable because person “A” receives less than 80% of the stock and person “B” receives stock not for property transfer. Both fail to meet post-control requirement.
A shareholder is taxed only for the stock he/she receives in return to the rendered services in cases when he/she receives stocks both for rendering services and transferring property to the corporation. He/she will be treated as a member of transferors’ group only if the stock earned through transferred property constitutes at least 10% of the stock earned through rendering service.
A momentary control after transfer cannot qualify for ultimate control of the corporation if the plan for disposition or sales exists before the acquisition of the stock.
Since the time lapse can result in the absence of transferring group in case of later transfers, a long-time lapse can cause in the loss of control of property by different shareholders. Although, regulations do not call for immediate transfer of property, a long time-lapse may treat the subsequent transfers as individual transfers.
Answer to question number 7:
Following issues may be hit while considering the incorporation of the proposed “The Perfect Cat”:
- Will the transfer be taxed or treated as tax-free according to the section 351?
- Will the transfer of property help Margaret receive stocks?
- If Margaret cannot be qualified as a property transferor, how her received stocks will be taxed? Whether the stocks will be classified as gifts from her mother or in exchange to the service she renders for the corporation?
- Will there be a preclusion of section 351 treatment for Nancy happen in case Margaret does not qualify as a transferor of the property?
- How the basis of stocks will be determined for Nancy and Margaret?
- How the basis of the property will be determined for the corporation?
- If the transfer of stocks to Margaret is in exchange for her service rendered to the corporation, what the income and deduction allowance will be?
- What tax consequences will it bring form Nancy if the received stock of her is treated as a gift from her mother?
Answer to question number 10:
According to the section 357 (a), a transfer of mortgaged property does not trigger any gain and hence it does not constitute to be a boot to the transferor shareholder. However, if the liabilities are to avoid tax or if any authentic business purpose is absent in the transfer, then the liabilities will be treated as boot. On top of that, if the total liabilities sum beyond the transferred property’s adjusted basis, then the exceeding amount will be treated as the taxable gain.
Answer to question number 19:
Fair market value = $193,200
Ethan’s basis $533,240= ($25,000 + $50,000 + $458,240)
Marie has an income of $193,200 and $193,200 basis in her 400 shares of stock and Ethan has income of $0 and $533,240 basis in his 1600 shares of stock.
Answer to question number 21:
Jocelyn’s basis in her stock will be computed in the following way:
Description Amount ($)
Basis in land transferred to the corporation 60,000
Basis in inventory transferred to the corporation 5,000
Total 65,000
Less: Mortgage on land assumed by the corporation 15,000
Jocelyn’s basis in her stock 50,000
Answer to question number 23:
Ion corporation has a basis of $565,500 in the equipment. Yvonne has a basis of $435,000 for her stock and Simon has a basis of $522,000 for his stock.
Working note:
Ion corporation has a basis in the equipment ($110,000 + $35,000) = $145,000.
Yvonne has a basis = $435,00
Simon has a basis = $130,000
Answer to question number 25:
Description Amount
Purchase Cost $60,000
Less: Sales Value $5,000
Loss $55,000
Deduct: 1244 stock $50,000
Capital Loss $5,000
Answer to question number 28:
No gain on exchanges would be recognized by any party if the three exchanges are part of a pre-arranged plan.
The gain that C will recognize on exchange is calculated below:
Recognized gain = value of property – basis of property
= $350,000 – $90,000
= $260,000
Therefore, the gain that C will recognize on exchange is $260,000.
The parties could structure the transaction by using section 351 if the property that Clyde contributes has a basis of $490,000 (instead of $90,000). The realized gains would not be recognized under this section. Hence, it would be a benefit for all the parties. Moreover, the loss of $140,00 {$490,00 (FMV) – $350,000 (basis)} on C’s exchange could be realized.
Answer to question number 36:
Alice will not be able to recognize the gain on the transfer. On the other hand, in return to the service Jane renders to Osprey corporation, Jane receives an income of $35,000.
Osprey corporation will have a basis of $25,000 and $50,000 in the property from the acquisition of Sara and Jane’s property respectively. It further has a deduction of $35,000 in business in return to Jane’ service.
Answer to question number 38:
Red corporation, upon the transfer of the land and cash, will not be able to recognize any income. As per the section 118, the transfer is a capital contribution incurred by a non-shareholder and hence will not be taxed.
Red corporation will achieve a zero basis in the land.
In case of property purchase, the Red corporation will experience a zero basis, whereas in case of inventory it will use $200,000 basis.
Answer to question number 39:
Date
MS Emily Patrick
36 Paradise Road
Northampton, MA 01060
Dear Ms. Patrick,
This letter regards to the event of the Teal Corporation being in debt and declared to be bankrupt in the running year and discusses about the tax consequences on its being bankrupt.
Under the facts given, Teal Corporation was formed a number of years ago with an investment of $200,000 cash, for which you received $20,000 in stock and $180,000 in bonds bearing interest of $8% and maturing in nine years. Later, you were paid an annual salary of $60,000. Our concluding remark is based on the facts mentioned above. Please feel free to contact us in case you find any inconsistency.
If 1244 code of the internal revenue code was followed in issuance of the stock, the sale of shares of small, domestic corporations should be deducted as ordinary losses instead of as capital losses. The treatment of $50,000 additional amount lent to open account is for business or non-business purpose bad debt, should supported by proof and please give the details about the primary motive in lending the money to Teal Corporation was to protect your employment with the corporation.
From another point of view, if you are in the business of lending money or buying, promoting and selling corporations, you might be able to deduct both the $180,000 and the $50,000 as business’s bad debts, which are treated as ordinary losses.
Please contact us in case of you need further clarification.
Sincerely,
ABC CPA.
