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XYZ Inc

Assume No Special Rules. Equipment – Basis 100k, FMV 200k. Jim. XYZ Inc. 100 Shrs Common Stock. 1. Jim recognizes 100k gain. 2. Corp recognizes 200k gain. 3. Jim basis in stock 200k, new holding period. 4. Corp’s basis in equipment 200k, new holding period.

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XYZ Inc

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  1. Assume No Special Rules Equipment – Basis 100k, FMV 200k Jim XYZ Inc 100 Shrs Common Stock 1. Jim recognizes 100k gain. 2. Corp recognizes 200k gain. 3. Jim basis in stock 200k, new holding period. 4. Corp’s basis in equipment 200k, new holding period. Special Rules Change All This - Maybe Corporate and Partnership Tax Instructor: Dwight Drake

  2. Rule 1: 351 Rule Equipment – Basis 100k, FMV 200k Jim XYZ Inc 100 Shrs Common Stock No gain or loss is recognized by the transferor on the transfer of property to a corporation in exchange for stock of the corporation if: 1. Property is transferred 2. Solely in exchange for stock 3. Transferor(s) in “control” “immediately after exchange. Two 80% requirements – 80% of all voting stock and 80% of total shares of each other class of stock. Result: Jim recognizes no gain or loss on the exchange. Corporate and Partnership Tax Instructor: Dwight Drake

  3. Rule 2: 351(b) Boot Rule Equipment – Basis 100k, FMV 200k Jim XYZ Inc Common Stock + Cash If 351 would apply except that corporation issues property in addition to stock (“boot”) to the shareholder, then shareholder recognizes gain on the property transferred to corporation equal to the lesser of: 1. The built-in gain on the property transferred – the excess of FMV over basis 2. The FMV of boot received by the shareholder. Result: If 80k cash boot, Jim recognizes gain equal to boot – 80k. If 120k boot paid by XYZ Inc in addition to stock, Jim would recognize gain equal to 100k – excess of 200k FMV over 100k basis. Corporate and Partnership Tax Instructor: Dwight Drake

  4. Rule 3: The 358 Basis Rule Equipment – Basis 100k, FMV 200k Jim XYZ Inc Common Stock + Cash If 351 applies to an exchange of property for stock in a corporation, the basis of the stock received by the shareholder equals: 1. The basis of the property transferred to the corporation in the hands of the shareholder, plus 2. Any gain recognized by shareholder ala the 351(b) rule, less 3. The FMV of any boot received. Result: IfXYZ Inc issues 100 share of its stock and 80k cash, Jim recognizes gain equal to boot – 80k, and Jim’s basis in stock is equal to 100k (basis in equipment), plus 80k gain less 80k boot = 100k. If 120k boot was paid by XYZ Inc in addition to stock, Jim would recognize gain equal to 100k. Basis in stock would equal 100k plus 100k gain less 120k boot = 80k basis. Corporate and Partnership Tax Instructor: Dwight Drake

  5. Rule 4: Shareholder Tacking Rule Equipment – Basis 100k, FMV 200k Jim XYZ Inc Common Stock + Cash If 351 applies to an exchange of property for stock in a corporation, the holding period of the property transferred by the shareholder is “tacked on” to the holding period of the stock if the transferred property was a capital asset or a 1231 asset (asset used in trade or business). No inventories or receivables. Result: Jim’s holding period of equipment is “tacked on” in determining holding period of stock. Corporate and Partnership Tax Instructor: Dwight Drake

  6. Rule 5: The 1032 Rule Equipment – Basis 100k, FMV 200k Jim XYZ Inc Common Stock + Cash Corporation recognizes no gain or loss on receipt of money or property in exchange for its own stock Result: XYZ Inc issues 100 share of its stock and 80k cash to its sole shareholder Jim for equipment worth 200k that has a basis of 100k. XYZ Inc recognizes no gain or loss. Corporate and Partnership Tax Instructor: Dwight Drake

  7. Rule 6: The 362 Rule Equipment – Basis 100k, FMV 200k Jim XYZ Inc Common Stock + Cash A corporation’s basis in property acquired in exchange for its stock in a transaction that qualifies under 351 equals the shareholder’s basis in the property basis plus any gain recognized by the shareholder. But if net built-in loss, basis limited to FMV of property unless all elect to reduce stock basis of shareholder to FMV. Result: XYZ Inc issues 100 share of its stock and 80k cash to Jim, Jim recognizes gain equal to boot – 80k. XYZ Inc.’s basis in equipment is equal to 100k (Jim’s basis in equipment), plus 80k gain recognized by Jim = 180K. Corporate and Partnership Tax Instructor: Dwight Drake

  8. Rule 7: Corporate Tacking Rule Equipment – Basis 100k, FMV 200k Jim XYZ Inc Common Stock + Cash If 351 applies to an exchange of property for stock in a corporation, the holding period of the property transferred by the shareholder is “tacked on” in determining the holding period of the property in the hand of the corporation. Result: Jim’s holding period of equipment is “tacked on” in determining XYZ Inc.’s holding period of equipment. Corporate and Partnership Tax Instructor: Dwight Drake

  9. Problem 434(a) 25k Cash / 25 Shares Note / 20 Shares X Corp Inventory / 10 Shares Equip. / 25 Shares Land / 20 Shares A B C D E FMV -10k Basis – 5k FMV - 20k Basis – 25k FMV - 25k Basis – 5k FMV - 20k Basis – 2k • 351 requirements satisfied. Hence: • A: No gain or loss. Stock basis 25k. Holding period starts on exchange. • B: No gain recognized; Stock basis 5k; no tacking holding period. • C: No loss recognition; Stock basis 25k; tacking holding period. • D: No gain recognition; Stock basis 5k; tacking holding period. • E: No gain recognition; Stock basis 2k; tacking holding period. Corporate and Partnership Tax Instructor: Dwight Drake

  10. Problem 434(b) 25k Cash / 25 Shares Note / 20 Shares X Corp Inventory / 10 Shares Equip. / 25 Shares Land / 20 Shares A B C D E FMV -10k Basis – 5k FMV - 20k Basis – 25k FMV - 25k Basis – 5k FMV - 20k Basis – 2k (b) Per 1032, X Corp recognizes no income on issuance of stock. X takes transferred basis in each asset (except land) and may tack holding period per 1223(2). Tacking is irrelevant to inventory, as it will be ordinary income or loss. Land 5k built-in loss forces basis reduction to FMV 20k per 362(e)(2)(A), unless C agrees to stock basis reduction to 20k. Corporate and Partnership Tax Instructor: Dwight Drake

  11. Problem 434(c) & (d) 25k Cash / 25 Shares Note / 20 Shares X Corp Inventory / 10 Shares Equip. / 25 Shares Two 10k Parcels / 20 Shares A B C D E FMV -10k Basis – 5k #1 – 15k Basis #2 – 8k Basis FMV - 25k Basis – 5k FMV - 20k Basis – 2k c) Two land parcels from C – each 10k FMV (20k total) and 23k combined basis (15k and 8k). May net built-in gains with built-in losses in applying basis adjustment of 362(e)(2)(A). Thus only 3k basis reduction, all allocated to built-in loss parcel, reducing its basis to 12k. As option, C could elect to take 3k basis reduction. d) What impact if X corp sells inventory for 10k and B sells stock for 10k. Both recognize 5k gain on inventory appreciation. Thus, double tax inherent in 351 carryover non-recognition impact. Note S Corp impact where shareholder basis is increased by S Corp income. Corporate and Partnership Tax Instructor: Dwight Drake

  12. Problem 443-1 (a) & (b) Newco Property / 10 Shares Preferred Property / 50 Shares Jan 2 March 2 A B FMV - 50k Basis – 10k FMV - 10k Basis – 1k (a) A transfer qualifies under 351 – A has no gain or loss; A stock basis 10k; tack holding period if asset was capital asset or 1231; Newco no gain or loss; Newco takes basis of 10k in property. B transfer not qualify under 351 – B sole transferor and no voting stock. B recognizes 9k gain; Stock basis is 10k; Newco no gain or loss; Newco basis in asset is 10k. (b) If both part of integrated transaction, 351 applies to both – A & B are both transferors and together own all voting and non-voting stock. Requirement of “immediately after exchange” does not require simultaneous transfers. Corporate and Partnership Tax Instructor: Dwight Drake

  13. Problem 443-1 (c) Newco Property / 10 Shares Preferred Property / 50 Shares Jan 2 March 2 A March 5 D B 25 Share Gift FMV - 50k Basis – 10k FMV - 10k Basis – 1k (c) A gift of half voting shares after integrated transfers should not impact 351 treatment for A & B. If gift on 1/5, between integrated exchanges, 351 is killed because not own voting control after transfers. Corporate and Partnership Tax Instructor: Dwight Drake

  14. Problem 443-1 (d) Newco Property / 10 Shares Preferred Property / 50 Shares Jan 2 March 2 A May 2 E B 15 Share Sale FMV - 50k Basis – 10k FMV - 10k Basis – 1k (d) Pre-existing promise to sale stock kills 351. E is not a transferor under 351, but is part of the plan. Corporate and Partnership Tax Instructor: Dwight Drake

  15. Problem 443- 2 (a) & (b) Jyve Inc. Assets / 200 Shares 5 Yr. Employment / 150 Shares Cash/ 150 Shares Java Venturer Manager FMV - 200k Basis – 50k 150 k Cash • 351 requirements not satisfied – services not property for 351 and Java and Venturer (the property contributors) do not have control. Java recognizes 150k gain on incorporation, and Manager has compensation income equal to FMV of stock received – as much as 150k. • If Manager pays 150k for stock - 351 then works. Note from manager may also qualify as property, but many state laws prohibit unsecured note for stock. May need to secure note with escrowed stock. Corporate and Partnership Tax Instructor: Dwight Drake

  16. Problem 443- 2 (c) & (d) Jyve Inc. Assets / 200 Shares 5 Yr. Employment Plus Cash for 150 Shares Cash/ 150 Shares Java Venturer Manager FMV - 200k Basis – 50k 150 k Cash c) Idea – Manager pays 1k for 150 shares of stock and documents say services of manager not consideration for stock. No hope under 351. Substance will prevail. Stock will still be deemed for services because property is “of relatively small value” compared to services. d) Manager pays 20k for stock? Since property transferred exceeds 10% of shares for services, not “relatively small value” per Rev. Proc. 77-37 and 351 available. This helps Java big time, but Manager still must recognize 130k on receipt of compensation-related shares. Corporate and Partnership Tax Instructor: Dwight Drake

  17. Problem 443- 2 (e) Jyve Inc. 5 Yr. Employment Plus Cash for 150 Shares 130 Subject to Risk Assets / 200 Shares Cash/ 150 Shares Java Venturer Manager FMV - 200k Basis – 50k 150 k Cash e) What impact if compensation related shares subject to forfeiture if Manager leaves within 5 years? Per Section 83, Manager not recognize until restriction lapse, but then recognize full FMV as ordinary income. 83(b) election allows recognition now, against risk of forfeiture and potential of more favorable capital gain treatment on growth. Corporate and Partnership Tax Instructor: Dwight Drake

  18. Compensation Gross-Up Game Assume: 1. Stock for services equal 150k 2. Corporation tax rate 34% 3. Executive tax rate 33% Straight recognition transaction: - Executive pays taxes of 50k - 33% of 150k. - Corporation saves taxes of 51k – 34% of 150k Gross up amount formula: [Stock value / (1 - Executive tax rate)] – Stock value = Gross-Up Tax Bonus [ 150k / (1 - .33 = .67)] – 150k = 74k - Corp tax savings: (150k + 74k) x 34% = 76k (More than Gross-up) - Employee tax bill: (150k + 74k) x 33% = 74k (Paid by Gross-up) Corporate and Partnership Tax Instructor: Dwight Drake

  19. Problem 453 (a) X Corp. 15k common 2k Cash 5k Pf 10k Common 5k Cash 35k Note 15k Common 15k Cash A C B 22k Equip Basis -15k 50k Land Basis -20k Inv 20k, Land 10k Basis: 7k Inv, 13k Land • A – 2k boot 1245 ordinary income; Stock basis 15k – 75% common, 25% preferred; holding period tacked; X basis is 17k; X may tack holding period. • B – 15k boot allocated 10k inv, 5k land; recognize 10k ordinary on inv, no loss recognition land; B Stock basis is 15k (20k – 15k(boot) + gain recognized(10K)); 1/3 stock tack, 2/3 not. X basis inv is 17k (7k + 10k), land 13k. Corporate and Partnership Tax Instructor: Dwight Drake

  20. Problem 453 (a) X Corp. 15k common 2k Cash 5k Pf 10k Common 5k Cash 35k Note 15k Common 15k Cash A C B 22k Equip Basis -15k 50k Land Basis -20k Inv 20k, Land 10k Basis: 7k Inv, 25k Land (a) C – 40k boot; 30k gain recognized; If no 453(d) elect out, C could use installment. 10k basis allocated to stock; other to 40k note and cash, with 25% (10k/40k) recovery ration. Of 5k cash, 3.75 recognized yr one; 75% of all future payments taxable. C stock basis is 20k start + 30k gain recognized – 40k boot received = 10k. X Corp land basis is 20k start + 3.75 yr 1 gain and increased as more payments received – ultimately to 50k. Corporate and Partnership Tax Instructor: Dwight Drake

  21. Problem 453 (a) Calculation for C (a) C - Detailed installment sales calculations: - Transferred basis (20K) first allocated to “permitted property” – the stock – up to FMV – here 10k. Prop. Reg. 1.453-1(f)(3)(iii). - Excess 10k transferred basis is allocated to boot – 5k cash and 35k note. Total boot of 40k, against basis of 10k, and gain of 30k. Thus, ratio of profit to total boot is 30/40 = 75%. - First year payment of 5k produce 3.75 income (5k x .75) - C basis under 358 determined without regard to 453 installment reporting. Hence is 20k transfer + 30k gain – 40k boot = 10k. - X Corp basis does use 453 installment. Hence, year 1 is 20k + 3.75k = 23.75k. Will eventually get to 50k as installment not paid. Corporate and Partnership Tax Instructor: Dwight Drake

  22. Problem 453 (b) X Corp. 15k common 2k Cash 5k Pf 10k Common 5k Cash 35k Note 15k Common 15k Cash A C B 22k Equip Basis -15k 50k Equipment Basis -20k Inv 20k, Land 10k Basis: 7k Inv, 13k Land (b) C instead transfers equipment with 50k FMV and 20k basis. Original cost 50k. All 30 income recognized as 1245 ordinary income, with no 453 installment reporting available. C stock basis is 10k. X Corp basis in equipment is 20k + 30k gain recognized = 50k. Corporate and Partnership Tax Instructor: Dwight Drake

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