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Exam 18: Corporations: Organization and Capital Structure

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Question 1

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

A) Wade has no recognized gain; Paul recognizes income/gain of $80,000.
B) Neither Wade nor Paul has recognized gain or income on the transfers.
C) Swan Corporation has a basis of $30,000 in the land transferred by Paul.
D) Paul has a basis of $30,000 in the 25 shares he acquires in Swan Corporation.
E) None of the above.

F) A) and B)
G) D) and E)

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Question 2

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Because services are not considered property under § 351, a taxpayer must report as income the fair market value of stock received for such services.

A) True
B) False

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Question 3

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

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.

What are the tax consequences if an individual investor incurs a loss on the following: a. Stock that is not § 1244 stock. b. Stock that is § 1244 stock. c. Corporate bond. d. An uncollectible loan made to a corporation.

Beth forms Lark Corporation with a transfer of appreciated property in exchange for all of its shares. Shortly thereafter, she transfers half her shares to her son, Ted. The later transfer to Ted could cause the original transfer to be taxable.

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.

Erica transfers land worth $500,000, basis of $100,000, to a newly formed corporation, Robin Corporation, for all of Robin's stock, worth $300,000, and a 10­year note. The note was executed by Robin and made payable to Erica in the amount of $200,000. As a result of the transfer:

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

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. a. Does Sean recognize any gain on the incorporation? Explain. b. What basis does Sean have in the Aqua stock? c. What basis does Aqua Corporation have in the assets it receives?

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?

Nick exchanges property (basis of $100,000; fair market value of $3 million), for 65% of the stock of Yellow Corporation. The other 35% of the stock is owned by Gloria who acquired it several years ago. What are the tax consequences to Nick?

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 consideration is transferred to a corporation in return for stock, the definition of "property" is important because tax deferral treatment of § 351 is available only to taxpayers who transfer property.

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.

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:

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

A person who performs services for a corporation in exchange for stock cannot be treated as a member of the transferring group even if that person also transfers some property to the corporation.

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.

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.