This course provides an introduction to the U.S. federal income taxation of corporations and their shareholders. The course focuses on the relevant provisions of Subchapter C of the Internal Revenue Code, as well as related Treasury Regulations and judicial opinions, governing corporate formation, operations, distributions, and liquidation. Practical in-class study problems facilitate self-discovery of technical tax knowledge along with the development of a variety of professional skills and attitudes.
Lesson 3.3.2 Non-Recognition Provisions: Applications
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来自 University of Illinois at Urbana-Champaign 的课程
Taxation of Business Entities I: Corporations
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从本节课中
Module 3: Corporate Formation I
In this module, you will review the taxation of property transactions. You will be introduced to the Sunchaser Shakery which is a firm that you will apply concepts to. Then, you will examine the nonrecognition provisions in property-for-stock transactions and consider possible exceptions and conditions.
与讲师见面
Michael P Donohoe, PhD, CPAAssociate Professor of Accountancy and PwC Faculty Fellow
Department of Accountancy, Gies College of Business
To apply the general concepts of section 1032 and 351,
let's keep things simple for now and add complexity as we progress.
Assume that each problem you encounter is
an independent situation unless indicated otherwise.
In this problem, Nicholas exchanges property with a $15,000 adjusted basis,
and a $42,000 fair market value for
70 shares of the newly created Sunchaser Shakery Corporation.
Emily exchanges accounting services worth $25,000 for the remaining 30 shares of stock.
And in part A, we want to know what amount of gain or loss,
if any, must Nicholas,
Emily and Sunchaser recognize on the exchange. So where do we begin?
Well, let's first start by looking at whether section 351 applies to this transaction,
because if it does, that will help us determine whether or not we need
to recognize any gain or loss on the transaction.
So let's briefly run through each of the components of
section 351 to figure out if it applies.
So, our first concern is whether or not we have
one or more persons transferring property.
And this is important because for 351 to apply,
we do need a transfer of property.
So do we have this situation? Well, yes.
We have Nicholas who's going to transfer property in exchange for stock.
However, Emily is transferring services,
which you learned in the concepts that services for
section 351 do not equate to property.
So in other words, as we apply this concept of section 351 to this problem,
we can not consider Emily in this situation.
Okay, so let's keep moving.
The next requirement we need is to determine whether or not this exchange or
property was made solely in exchange for stock.
In other words, did Nicholas receive anything else other than stock?
And in this situation, no,
he didn't receive anything else.
So his exchange was solely in exchange for stock.
So we're good here.
And then our final concern is whether there is control of
the corporation immediately after the exchange.
And recall that control for purposes of section 351 is defined
at the 80 percent threshold of both voting and non-voting shares if they exist.
So here though, we cannot include Emily shares of stock
because she did not transfer property, only Nicholas did.
So for looking at Nicholas's shares to determine what he receives.
During the transaction it says that he received 70 shares,
which means Emily receives the other 30 shares,
which was indicated in the problem.
So after the exchange,
Nicholas only holds 70 percent of the shares.
This is obviously less than 80 percent.
And so, we do not meet the control requirement for section 351.
So in other words,
section 351 does not apply to this transaction and that's obviously important for us.
Okay, so with this in mind,
let's now go to each of the three parties involved in the transaction
to figure out the taxation of this specific situation.
So let's begin with Nicholas.
Well, in most property problems we're always going to begin in
the exact same place with the amount realized,
that is what did Nicholas receive in the transaction?
In other words, what's coming in the door to him.
And so, we see that in the problem,
it says that he is giving up property with the fair market value of $42,000.
In the case of a closely held corporation such as Sunchaser,
there is no open market for their shares
such as in New York Stock Exchange or something similar.
So in this situation, basically,
it's a presumption that we make in tax that the value of the stock
he receives will be equivalent to the value of the property he transferred.
In other words, he's going to receive $42,000 worth of stock,
making in an arm's length transaction.
So we're not concerned about what's the adjusted basis of the property that he gave up.
And it says in the problem that he contributed property with the $15,000 adjusted basis.
So this means that he has a,
just abbreviate with our LCD,
realized gain of $27,000.
So how much of that realized gain then is he required to recognize on his tax return?
Well, under section 1000 1b,
we're told that anytime we have a realized gain we typically recognize it,
unless another code section kicks in to tell us not to recognize it.
Such a code section in this situation would be 351.
But we just determined that that code section does not apply to this situation because
Nicholas does not have control on his own after the transaction,
and we're not allowed to include Emily shares in this situation.
So because 351 does not apply,
1000 1b will apply,
forcing him to recognize the $27,000 gain.
Okay, so that's it for Nicholas.
Now let's consider Emily.
So Emily, in this situation,
351 does not apply to her either as we
determined because she does not transfer any property,
instead she transfer services.
So, in the event she transfer services, when she does,
she is going to recognize the value of the stock she receives for those services.
So the fair market value of her services, $25,000,
will be included in her taxable income as
basically compensation for her services under Section 61.
So in other words, she'll pay tax on the $25,000.
And now let's look at Sunchaser,
the final party to this transaction.
When it comes to a corporation,
we're not concerned about section 351 because
Section 1032 governs the corporation and in that situation.
Just remember section 351 only applies to potential shareholders.
That is the transfer ore's.
So for the corporation,
section 1032 says no gain or loss to a corporation when dealing with their own stock.
So in this situation Sunchaser issuing its own stock,
so there is no gain or loss on the transaction.
So that is the answer for the corporation.
So that is everything for part A.
Now let's take a look at part B which says,
let's assume the same facts except Nicholas and Emily
received 82 and 18 shares, respectively.
So what changes in this situation?
We still have one or more persons transferring property.
It's still solely in exchange for stock except now,
Nicholas all on his own is going to achieve the 80 percent control threshold.
And so, if we just look at the control aspect here for
a moment then we see that Nicholas will now have
82 of the 100 shares outstanding,
or in other words, 82 percent.
So control is now officially met,
which means section 351 would apply to the entire transaction.
In other words, we don't need Emily shares for Nicholas to obtain control.
Let's say applies.
So in this case, now with 351 applicable,
Nicholas will recognize no gain or loss.
Emily still recognizes $25,000 because she did not contribute property.
So 351 does not apply to her.
So she'll have $25,000 of ordinary income.
And then as before.
Sunchaser which is not governed by 351 because it's not the transfer or shareholder,
it's the corporation, it also recognizes no gain
or loss on the transaction under section 1032.
And that's it.
Nicholas transferred property with the fair market value of $85,000
and services worth $15,000 to Sunchaser Shakery Corporation.
He received Sunchaser stock worth $100,000 in exchange.
Immediately after the exchange,
Nicholas own 100 percent of the only class of outstanding stock.
What are the tax implications of this transaction?
So where do we begin? We'll begin where we always begin with these types of situations.
Let's figure out if section 351 will apply because that will ultimately help us
determine whether there's any gain or loss for Nicholas to recognize.
So to figure out if section 351 applies,
we'll follow the same approach that we did before and examine if each of
the three key provisions of section 351 are met.
So the first one again,
is that we need one or more persons
transferring property.
And here, we have Nicholas
transferring property and services in this particular transaction.
So he does transfer property but he also transfer services,
and we know that services do not equate to property for purposes of section 351.
But because property is present,
we do get to say yes to this particular question and move forward but we will have
to account for those services separately when we get a little bit further along.
So we have property and services.
So we can't forget about the services issues.
But because we have property,
we've met this requirement.
Second requirement is whether it's solely in exchange for stock.
In other words, did he get anything else in return?
And he did not. He only got the stock.
So solely in exchange for stock?
The answer is yes. And in subsequent lessons,
we'll learn what to do when there is something else there.
And then the final is that we must have control immediately after the exchange,
which is the 80 percent threshold.
And the problem says that Nicholas own 100 percent of
the only class of outstanding stock after the exchange.
So control is met once the transaction is complete.
So this is a situation where section 351 does indeed apply.
But we do have the services and property issue to deal with.
So how are we going to handle this?
Well, we're going to break these two components of the transaction out.
So let's first consider that he contributed $15,000 worth of services,
and we know that services are not property under section 351.
So services are not property.
Therefore, this $15,000 will be taxable income or compensation under section 61.
In other words, taxable to Nicholas.
However, for the property that he transfers,
he's going to recognize no gain or loss,
because the section 351 was still met even though he transferred property as well.
We just have to break out the two components.
So no gain or loss on property because of section 351.
Now for Sunchaser, to cover both sides of the transaction,
both counter-parties, we have also no gain or loss recognized.
And the reason is section 1032 which says that a corporation does not recognize
any gain or loss on the issuance or dealings in their own stock.
And that's it again.
Which of the following classes of securities are
considered stock in a section 351 transaction?
Voting preferred stock, voting common stock,
nonqualified preferred stock, nonvoting preferred stock,
stock rights and warrants.
Section 351 is flexible with respect to stock issued by corporation.
However, there are a few items that are not
considered stocks specifically for section 351.
And particularly, the code section is pretty clear and it states that
non-qualified preferred stock is specifically excluded.
So that would be these right here,
as well as any stock rights and warrants. Why is this?
So if we think about nonqualified preferred stock,
the reason that it's special is that it actually resembles debt.
So it's not truly equity interests.
So in other words, it would be hard to establish control of the corporation.
The same thing goes with stock rights and
warrants because they're not actual ownership shares.
So not actual shares,
it's just the right to acquire shares.
So if you have the right to acquire shares,
that's different than actually having control of
the corporation by actual share ownership.
So these two items would be excluded from this definition.
However, any shares of preferred stock would be
included whether voting or nonvoting as well as any voting common stock.
So in other words, the items in green would be
considered stock in a section 351 transaction,
while the two items in red are specifically excluded by section 351.
Nicholas transferred cash and property to
Sunchaser Shakery Corporation solely in exchange for stock of the corporation.
Immediately after the exchange,
Nicholas owned 80 percent of the total combined voting power of all classes
of stock entitled to vote and 53 percent of all other classes of stock.
And we want to know if the transaction meets the requirements of section 351.
So clearly the issue for
this particular transaction is whether the control requirement is met.
So if we go back to the concepts where we learned about the control requirements,
code section 368 c states that,
"The ownership of stock possessing at least 80 percent of
the total combined voting power of all classes of stock
entitled to vote and at least 80 percent of
the total number of shares of all other classes of stock of the corporation."
In other words, for the control requirement to be satisfied,
the individual shareholder must have 80 percent of
both voting and non-voting shares if they exist,
which obviously in this particular transaction,
those types of shares do exist.
So if we look at the actual problem,
it says that Nicholas owns 80 percent of the total combined voting power,
and 53 percent of non-voting shares or other classes it says.
Well, this is not 80 percent and 80 percent,
it's only 80 percent and 53 percent.
So because the 53 percent is less than 80 percent,
Nicholas does not meet the control requirements and therefore,
this transaction does not satisfy the conditions of section 351.
