Agenda BA128A-1 4/12

1. Agenda BA128A-1 4/12 • Return exams • Go over exam • Projects • Review - Chapter C2 • Assignment - C2-30,33,40 • Additional - C2- 38,39

2. Forms of organizations • Sole Proprietorship • report all business income/loss on individual tax return • adv - no double taxation, loss can offset other source of income, withdraw/put $ without tax consequences • disadv - income flow through, self employment taxes, no tax-exempt fringe fringe benefits • Partnerships • tax reporting entity • adv/disadv similar to sole proprietorship • additional adv - partnership basis increase by share of income - ie reduce gain recognized if sold later

3. Corporations • C-corp, S-corp • C-corp • tax rate 15%- 35% • SH not taxed on earnings but on distributions • Dividends taxed at ordinary rate • Capital gains taxed at disposal • Adv - lower tax rate?, not taxed if earnings not distributed (accumulated earnings tax limitation), can deduct salary payments, tax free fringe benefits, use of fiscal year vs. calendar year, disposal of qualified small business stock can exclude half of the capital gain • Disadv- double taxation, put or withdraw$ may have tax consequences, no NOL/capital loss benefit in current year

4. S-corp • Flow through entity • SH taxed like partnership for fed income tax partnership but enjoy other advantages of corporations like limited liability • adv - exempt from corporate tax, losses flow through to SH to offset other income, SH contribute/withdraw $ without tax consequences, SH basis increase when income is recognized • disadv - lots of restrictions e.g. number of SH, can’t choose fiscal year, no tax free fringe benefits, all income taxed to SH

5. Check the box regulations • Before this rule, entities are taxed as corp if possessed 3 of the 4 characteristics, limitied liability, centralized management, free transferability, continuityof life • Emergence of LLC and LLP, taxed as partnership but with limited liability • Check the box regulations - allow unincorporated business to elect to be taxed as partnership/sole proprietorship or corporation • Default rules - if doesn’t elect, taxed as partnerships (2 or more) and sole proprietorship (1 person)

6. Legal requirements of forming corporations • Minimum amount of capital • State incorporation - corporate charter by state • Articles of incorporation - purpose, name, type of stock, board members, • Issuance of stock • Annual franchise fee and incorporation fee

7. Tax considerations in forming corporations • Tax free and taxable transfer of property • Section 351 - allows the deferral of gains and loss upon incorporation, apply to new and existing corporation • Requirements - • for stock • transfer in control immediately after exchange (no prearranged plan to sell) • Property must be transferred • Control - >= 80% of total voting stock and >=80% of each class of nonvoting stock • Property - money, A/R, inventory, equipment, intangibles and etc. • Exclusions - services, indebtedness with no security

8. Other 351 considerations • Transfer of both prop and services • all stock count towards 80% control if property >=10% of property transferred • disproportionate transfer, basis may be adjusted • Non simultaneous exchange OK, but transactions should be executed expeditiously and orderly • Preferred stock that is not qualified • stock redemption provisions • dividend rates varies with interest rate or price indices • stock rights and warrants not qualified

9. Receipt of Boot • SH receives cash, notes • SH recognized gain up to lesser of realized gain or FMV of boot • Character of gain depends on asset received • SH basis = adjusted basis of property transfer + gain recognized - (boot received, cash received or liability assumed by transferee (ie corp)) • SH holding period - include property’s holding period

10. Transferree Corp’s Recognition • No recognition if transfer stock even if 351 is not applied • If transfer appreciated property as part of section 351- recognized gain but not loss • Transferee corp basis = transferor’s adjusted basis for property + gain recognized by transferor • Holding period includes holding period of transferor + any depreciation recapture potential

11. Choice of capital • Debt • adv - deductibility of interest, no recognition of income upon repayment • disadv - transfer of property at FMV • scrutinized by IRS - nature of debt may look like equity • Equity • adv - 70% - 100% dividend received reduction • section 351 - allow transfer at basis • stock dividend distribution is tax free • section 1244 allows recognition of ordinary loss if small stock becomes worthless • exclusion of half of capital gain for disposal qualified small business stock • disadv, cash dividends taxed at ordinary income, redemption of stock is taxed as dividend

12. Capital contribution by SH • Voluntary • no gain/loss recognized by corp • SH basis of stock increased • Basis of property = basis of property contributed + gain recognized by SH • Involuntary contribution • regard as an exchange transaction • SH must recognized G/L of property

13. Capital contributions by non SH • Basis of property of corp is zero • prevent company from claiming additional depreciation • If contribute cash, and cash used to buy property, basis of property needs to be reduced, if $ not spent in 12 months, reduce basis of other property- order - depreciable prop, amort. Prop, depletable prop and all others

14. Worthless security • Capital loss on last day of tax year where worthless occur • include stock, bond and the right to subscribe/receive a share of stock • Ordinary loss - securities that are not capital assets, affiliated corp (80%), section 1244 qualified small business stock (limited to $50,000 a year for single)

15. Unsecured debt obligations • Unpaid loan not evidenced by a security • Non-business bad debt - investments - STCL • Business bad debt - deducted as ordinary business deductions - in connection with trade or business, loan to keep employment