3.4 - Related Party Transactions

Question 1

What prevents taxpayers from shifting ownership of stock or property to a related person or entity in an effort to take advantage of beneficial provision while essentially still controlling their original investment?

Answer 1

Provisions of section 267 of the internal revenue code

Question 2

Section 267 of the internal revenue code defines related parties as:

Answer 2

Siblings
Spouses
Ancestors and descendants
Entities that are more than 50% owned

Question 3

Who is not considered a related party?

Answer 3

In-laws and step relationships

Question 4

Kathy owns 80% of Company A. Company A owns 30% of Company B. What’s Kathy’s ownership percentage of company B?

Answer 4

80% X 30% = 24%

Question 5

Chad owns 30% interest in company A. His wife owns 20% interest, his grandson owns 5% interest and his nephew owns 15% interest. Determine Chad’s ownership in company A.

Answer 5

30% + 20% + 5% = 55%

Nephew is not included

Question 6

Company A owns 40% of company B an 30% of company C. Company C owns 40% of company B. Determine whether company A and B are related parties.

Answer 6

Yes, because company A owns 52% of company B (40% X 30% = 12% 12% + 40% = 52%)

Question 7

Capital gains tax is imposed on all sales of non-depreciable property (land)) between related parties except for what sales?

Answer 7

Sales between 2 spouses
An individual and a 50% plus controlled corporation ARO partnership (taxed as ordinary income)

Question 8

How are losses on related party sales treated?

Answer 8

Losses are disallowed

Question 9

What are the gain rules for related parties?

Answer 9

The basis is the same as the basis for gift tax (depends on future selling price)

Question 10

Ned bought stock for $20,000 that he sold to his brother, ray, for $16,000. The $4,000 loss is disallowed. Ray then sells the stock to Bobby, and unrelated party for $21,000. Determine ray’s basis and his recognized gain or loss on the sale.

Answer 10

Basis = 20,000 because 21,000 selling price is greater than the cost and selling price from Ned

21,000 - 20,000 = 1,000 recognized gain

Question 11

What prevents parties from offering below-market interest rates on loans that could be particularly appealing to related parties?

Answer 11

Section 7872 of the IRC

Question 12

Individuals who do make a. Below-market loan generally must do what?

Answer 12

Report any foregone interest as interest income. The borrower may be able to edict the foregone interest.

Question 13

What loans does the below market loan provision apply to?

Answer 13

Gifts
Compensation related loans
Corporation shareholder loans

Question 14

What is the de minimis exception to the below market loans provision?

Answer 14

The imputed interest rule does not provide for:
Gift loans between two individuals with an amount below 10,000
Compensation related and corporate shareholder loans with an amount below 10,000

Question 15

What is the special rule for gift loans between individuals is less than $100,000?

Answer 15

The foregone interest to be included in income by the lender and deducted by the borrower is limited to the amount of the borrower’s net investment income for the year

Question 16

Mike loans $200,000 to his sister payable in 10 years at an annual interest rate of 1%. The AFR issued by the IRS for long-term loans is 2.24%. Determine whether mike’s loan qualifies as a below-market loan and if so, calculate the imputed interest income to mike.

Answer 16

1% < 2.24% - therefore the loan is a below-market loan.

200,000 X 2.24% = 4,480 interest required under AFR
200,000 X 1% = 2,000 interest payable under the loan

4,4800 - 2,000 = 2,480 imputed interest