Ch12: TaBS, Corporate Formations

Question 1

Section 351

Answer 1

Corporate formations are usually non-taxable under 351.

3 requirements:

1. investors contribute property to the corporation
2. investors receive stock compensation
3. investors collectively control at least 80% of the corporation after the transaction

351 defers taxation on unrealized gains if the investors sell their stock; the length of holding time on the stock includes the length of time that investors held their contributed property.
Ex. if the investor held contributed property for 12 months, then he is treated as if held the stock for 12 months.

Question 2

Boot

Answer 2

The compensation that is not company stock investors in a 351 transaction receives for their contributions.

Question 3

Tax Basis

Answer 3

The investor’s tax basis is equal to the purchase price of the property contributed, NOT its fair market value; the tax basis should equal the sum of the basis of the property contributed and any cash contributions.

Question 4

Substituted Basis

Answer 4

The investors’ tax basis in the property that they receive is determined by the tax basis of the contributed property.

Stock Basis = Tax basis in the property contributed

Shareholders of a target take a basis in the stock received by the acquiring firm equal to the basis in the assets or stock that they gave up in the acquisition.

Question 5

Carryover Basis

Answer 5

A basis in the property received that is derived from the transferor’s (who contributed the property) original basis.

Question 6

Book-Tax Differences

Answer 6

The differences that separate book income from tax income are book-tax differences.

Question 7

Adjusted Tax Basis

Basis

Answer 7

The tax basis less accumulated depreciation is referred to as the adjusted tax basis; PPE net

Question 8

Capital Asset

Answer 8

Capital assets give rise to capital gains and losses: stocks, bonds, options etc.
Equipment and buildings used in a trade or business are NOT capital assets.

Question 9

Section 1231 Assets

Answer 9

1231 assets are noninventory assets that are used in a trade or business and held for more than 1 year; inventory doesn’t qualify under 1231.

1231 assets give rise to long-term gains and ordinary losses that can offset ordinary income.

Question 10

Ordinary Income

Answer 10

For a corporation, ordinary income is often taxable income and includes any income earned not stemming from capital assets; revenue, wages, interests income, etc.

Question 11

Distribution

Answer 11

A distribution can be a dividend from a corporation; it is cash or property paid to shareholders without requiring something in return.
Distributions are taxed 3 ways:
1. Dividend; often taxed at a 20% rate as taxable income to the shareholder
2. Return of Capital; non-taxable, but reduces the shareholder’s adjusted basis in the corporation’s stock by the amount of the distribution
3. Return of Capital and Capital Gain; if the distribution reduces the shareholder’s basis in the stock to zero, any excess distribution is taxed as a capital gain to the shareholder

Question 12

Redemption

Answer 12

Redemption or repurchase is when a corporation pays cash or property to its shareholders in return for some of its stock.

Question 13

Distribution taxed as a dividend

Answer 13

The shareholder is taxed on the distribution amount; the shareholder’s stock basis is unchanged.

Question 14

Distribution taxed as a return of capital

Answer 14

The shareholder’s stock basis is reduced by:

[Stock Basis before the distribution - distribution amount]

Question 15

Gain on stock sale

Answer 15

[FmV of property contributed - tax basis in property contributed]

Question 16

Distribution taxed as a return of capital and capital gain

Answer 16

Any return of capital reduces the shareholder’s stock basis to zero; any remaining return of capital is taxed as a capital gain.

Question 17

Earnings and Profits

Answer 17

Current Earnings and Profits is analogous to Net Income

Accumulated Earnings and Profits is analogous to Retained Earnings

Question 18

Section 351 taxable gain

Answer 18

Investors are taxed on the minimum between their realized gain, the difference between the fair market value and the tax basis of the property contributed, and boot compensation.

taxable gain = min [(FmV - Tax Basis), Boot)]

If services are included in the contribution that enables at least 80% control, the ownership stake is recognized, but investors are taxed on the services they provide as part of their contribution.

Question 19

Substituted Basis with Boot

Answer 19

If investors receive boot compensation, their basis in the stock that they receive is:

[(tax basis) + (gain) - (boot)]