FORMATION
I. §351, What does it do?
-In general, transfers of assets to corporations in exchange for stock is a
non-taxable even, when transferors maintain control of the corporation.
II. Why?
A) Investor’s status typically has not truly changed (merely the form of holding the
assets has changed).
B) Wherewithal to pay-can not pay taxes with stock certificates, would have to sell
stock or assets to pay tax.
III. Nuts & Bolts of §351. (Mandatory, if the following are met)
A) Property (not services) traded for stock (common or preferred).
B) Must have control immediately after the exchange.
1) >= 80% voting shares and
2) >=80% all shares.
C) Can be an individual or a group of individuals if all are part of an integrated
transaction. You can turn around and sell, just do not plan to do that. Individuals
do not have to transfer simultaneously, however, it should be according to a
preexisting plan.
D) To transfer for services, that member must also transfer a significant amount of
property (to be safe, 10% of value of services, Rev. Proc. 77-37) to be included in
group. If this is done, the stock received for services will be counted towards the
80% control requirement (although, the value of the stock received for services will
be taxed as service income).
E) For transfers to an existing corporation, new transferors must own 80% stock after
the new exchange. This requirement is harder to meet when dealing with a group of
investors.
IV. Basis considerations - Generally, a carryover basis.
A) Basis of stock to shareholder = basis of property + gain recognized - boot received
B) Basis of property to corporation = basis to shareholder + gain recognized
C) Holding periods are carried over as well.
V. Transfer of Liabilities - What happens with the receipt of debt in like-kind exchanges, e.g.
A) §357(a) allows that in an otherwise qualifying §351 transfer, the assumption of
liabilities by the corporation on property transferred to the corporation will not
result in boot.
B) §357(b) is an exception to (a). If the purpose of the assumption is to avoid tax, or
there is no business purpose, the liability is treated as boot. (Generally, this occurs
when the liability is created shortly before the transfer)
C) §357(c) is a second exception to the general rule. If the sum of liabilities assumed
by the corporation is > the sum of the adjusted basis of property transferred, the
excess is taxable gain. (Avoids situations of negative basis)
VI. Debt vs Equity in capital structure
A) Tax advantages of debt
1) interest from debt is taxed only once (due to the corporations interest
deduction).
2) when business debt becomes worthless (bad) the result is an ordinary loss,
whereas worthless stock generally results in capital loss (§1244 stock is an
exception).
3) issuing debt in an existing corporation does not affect ownership
percentages.
4) Is generally considered a less risky security than stock, although, debt
consequently has lower average returns than stock.
B) Characteristics of Debt generally considered by IRS and courts.
1) reasonable interest
2) maturity date
3) proper contractual form
4) interest paid on a timely basis
5) interest not contingent on earnings
6) is debt subordinated to other debt
7) debt/equity ratio