Chap C2

							Chap C2

Types of entities:

Sole proprietorship
- entity not taxed, include on 1040 Sch C
- losses can offset other income
- can contribute & withdraw $ without tax consequences
- profits taxed even if not distributed (reinvested)
- owner not an employee (benefits, SE taxes payroll taxes, salary)
- limited tax year

Partnership (General vs limited):
- tax reporting, not taxpaying entity. file 1065
- losses offset other income of partner, but passive loss rules may apply
- profits taxed even if not distributed (reinvested)
- partner not an employee (benefits, SE taxes, payroll taxes, salary)
- limited tax year
- inc and losses flow from pship to partner for reporting on 1040.
- distributions received generally tax free

S Corps
- generally not a taxpaying entity. file 1120S
- losses offset other income of SH, but passive loss rules may restrict
- profits taxed even if not distributed (reinvested)
- SH’s generally not considered employees
- limited tax year
- inc and losses flow from Corp to SH for reporting on 1040.
- distributions received generally tax free

C Corps
- taxpaying entity with rates from 15-35% (with bubbles)
- file 1120
- SH not taxed until receive a distribution (double tax aspect)
- SH can be employee (salary, bonus, benefits). Can minimize double tax effect
- Can have fiscal year
- NOLs provide no benefit for that year, can cb for refund or cf to reduce tax liab

Check the Box:
- unincorporated p/s or LLC can elect to be taxed as a corp

Forming a Corp:
- Sec 351 allows for no g/l on exchange of property for stock of a corp. no change of
   SH economic position

To preserve any pre-exchange gain, the basis of the property carries over.
351 Requirements:

1. property (includes know-how, patents, etc) is transferred to corp, not services

2. in exchange for stock (not debt, stock rights or warrants)

3. transferors of property must be in control of corp immediately after transfer (own >=
   80% of voting shares, and >= 80% of all other classes of stock)

4. if you transfer both services and property, the value of the property should be at least
   10% of value of services for that transferor to be included in control test.

On transfers to existing corp, be careful of 80% requirement. May need other s/h’s to
contribute property. Not an issue if you are just contributing cash, no gain with cash.

Shareholder effect:

-   no gain unless property other than stock received (notes, cash, etc). losses not allowed
-   if boot received, recognize gain up to amount of boot received

Basis:

Stock of s/h = C/O basis of property transferred + recognized gain/income – boot
received (include liabilities assumed by corp).

Basis of boot property to SH is its FMV

Holding period:

1. If capital asset or 1231 property transferred, tacked on holding period.

2. Starts day after exchange for all other property.

3. Split periods. May be issue if sell stock within 12 months.

4. Corps holding period tacks on from the s/h’s

If stock received for services performed, income to s/h, and deduct (or capitalized
expense) to corp

Corp effect:
- no g/l when issue stock or debt for property or services
- recog gain, not loss if transfer appreciated property to transferor
- depr recapture c/o from transferor
- continue to depr property after transfer. Allocate exp in year of transfer
Basis of property to the corp:

-   C/O basis from s/h + gain recognized by s/h.
-   No gain/loss recog by corp when issue stock for property/services
-   Recog gain, no loss if transfer appreciated property to SH as part of 351 exchange

Assumption of liabilities by Corp:

1. not boot to s/h as long as

a. tax avoidance is not motive, no business purpose (look at when liab was incurred and
   when it was transferred to corp. is it personal liab?). one bad liab taints all liab, all are
   then boot

b. liability is not in excess of basis of property transferred. Excess is gain to s/h, even if
   have no realized gain on the property exchange (exclude liabilities which would give
   a deduction when paid, ie A/P)

Liabilities assumed by corp reduce stock basis to s/h.

Sec 351 Filing Requirements in the year of formation:

Attach a statement to tax return detailing:

1. Description of property transferred with the adjusted basis of the property

2. The kind and number of shares received along with the FMV of the shares

3. The FMV of any other property (non-stock) received by transferor

4. If liabilities were transferred, details of the nature of the liabilities, when they were
   created, the corporate business purpose for the assumption of the liabilities and
   whether the assumption eliminates the transferors’ primary liability.

Debt vs Equity:

1. Debt gives interest deduction

2. Equity does not get a dividends paid deduction.

3. A tax benefit for debt

If debt has too many features of equity, the IRS may recharacterize the debt as equity and
disallow the interest expense and reclass the principal and interest as dividends to the s/h.

Factors of debt vs. equity
1. Is debt in proper form. Open advances can be ruled as capital. Want a formal note.

2. Does the note have reasonable interest rate and a definite maturity date

3. Are payments being made timely

4. Not contingent on profits

5. Is it subordinate to other debt

6. Is it held in same ownership % as the stock

7. What is ratio of s/h debt to equity.

Worthlessness of Stock

-   loss on last day of tax year it becomes worthless (character of loss: how do you hold
    stock, investment or inventory)
-   1244 issues (50/100K ord loss if qualifying original issue)

Unsecured debt obligations (loans to corp)
- loss type depends on nature of loan
a. if made in connection with stock investment, nonbusiness bad debt (STCL)
b. if made in connection with SH’s employment, business bad debt, ord loss.
- look at relative $ invested in stock, compensation from corp and other compensation