CCH Federal Taxation Comprehensive Topics Chapter 14 Taxation of Corporations— Basic Concepts...

CCH Federal TaxationComprehensive Topics

Chapter 14

Taxation of Corporations—Basic Concepts

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CCH Federal Taxation Comprehensive Topics 2 of 115

Chapter 14 Exhibits

Chapter 14, Exhibit Contents A

1. Selecting an Entity (Table 1)—Nontax Differences Among Entities 2. Selecting an Entity (Table 2)—General Tax Differences Among Entities 3. Selecting an Entity (Table 3)—Differences in Eligibility Among Entities 4. Selecting an Entity (Table 4)—Differences in Tax Treatment Among Entities 5. Corporation Defined 6. C Corporations—Special Types 7. C Corporations—Tax Years 8. C Corporations—Accounting Methods 9. C Corporations—Tax Formula10. C Corporations—Comparison with Individual Taxpayers11. Income Items Requiring Special Treatment12. Exclusions Requiring Special Treatment13. Deductions Requiring Special Treatment—Organizational Expenditures14. Dividends Received Deduction—Example 115. Dividends Received Deduction—Example 2


Chapter 14 Exhibits

Chapter 14, Exhibit Contents B

16. Deductions Requiring Special Treatment—Charitable Contributions17. Charitable Contributions—Example18. Deductions Requiring Special Treatment—Interest Expense and Original Issue

Discount19. Interest Expense and Original Issue Discount—Example20. Deductions Requiring Special Treatment—Bond and Stock Redemptions at a

Premium21. Deductions Requiring Special Treatment—Compensation and Educational

Reimbursement 22. Deductions Requiring Special Treatment—Rules for Net Operating Losses (NOLs)23. Net Operating Losses (NOLs)—Example24. Deductions Requiring Special Treatment—Capital Gains and Losses25. Deductions Requiring Special Treatment—Depreciation Expense26. Depreciation Expense—Example27. Reconciling Book and Taxable Income28. Corporate Tax Rates


Chapter 14 Exhibits

Chapter 14, Exhibit Contents C

29. Corporate Tax Credits30. Corporate Tax Credits—Example31. Consolidated Returns32. Consolidated Returns—Example33. Estimated Taxes34. Accumulated Earnings Tax (AET)35. Personal Holdings Tax (PHC)36. Formation of C Corps, S Corps and Partnerships—Owner Perspective37. Formation of C Corps, S Corps and Partnerships—Entity Perspective38. Formation of Corporations—Overview of Code Sec. 35139. Code Sec. 351 Contribution of Part Property/Part Services—Example40. Code Sec. 351 Contributions—Tax Effect on Shareholders41. Code Sec. 351 Contributions—Tax Effect on Corporations42. Code Sec. 351 Contributions—Example 143. Code Sec. 351 Contributions—Example 2


Selecting an Entity (Table 1)—Nontax Differences Among Entities

What entity form is best for a new business?

General rules for small businesses:

1. Taxes should not be a motivator unless there are no nontax differences.2. If no need to incorporate, generally better to be a limited liability company taxed as a partnership.3. If there is a need to incorporate, generally better to be an S corporation.4. If there is a need to go public, a C corporation is usually the only choice.

Chapter 14, Exhibit 1a


Actual rights to individual P/S assets; can bind partnership; each GP has equal right to run business.

Same as C corp

Rights to investment in stock, but not corporate asset; cannot bind corp.

Rights of owners

P/S dissolves after Departure of 50% GP(s); or Operations cease.

Same as C corp

Going concernContinuity of ownership

Each general partner (GP) has personal liability for P/S debt, & a direct interest in the P/S assets.

Owners of LLCs have limited liability; but may not appoint 3rd parties to board of directors.

Same as C corp

Limited liability to extent of investment.

Exposure of owners

General Partnerships (G P/Ss)S CorpC Corp

Nontax Differences


Chapter 14, Exhibit 1b


Nontax Difference

C Corp S Corp General Partnerships

Raising equity capital

Equity capital can be raised through public stock offerings; however, less flexible in bringing in different forms of ownership (i.e., must maintain preemptive ownership %. the preemptive restrictions are waived if employees are offered equity participation through treasury stock)

Same as C corp

Cannot trade a general partnership interest on a public exchange, but can trade a limited partner interest publicly; more flexible than corporations with forms of equity (e.g., can give out common or preferred P/S interest with no tax consequences)

Raising debt capital

Banks may be more willing to lend to corporations

Cannot go public

Can more easily write custom financing instruments (e.g., preferred debt with conversion rights)


Chapter 14, Exhibit 1c


Nontax Difference

C Corp S Corp General Partnerships

General administration

Simplified with centralized management.

Same as C corp

Can be too cumbersome to operate effectively without centralized management like corporation, since the # of GPs may exceed 75. GPs are subject to jurisdiction of the state.


Only if nontax differences weigh equally should one weigh the tax difference.

Chapter 14, Exhibit 1d


Selecting an Entity (Table 2)—General Tax Differences Among Entities


10% on TI up to $7,300 in 2005 for individuals; $14,600 for joint filers

Same as partnership

10% on taxable income (TI) up to $50,000

Lowest Marginal Tax Rate

35% whether or not income is distributed

Same as partnership

35% if income is not distributed (but 15% accumulated earnings tax or personal holding company penalty possible);

44.75% if income is distributed. (35% + 15% x 65%) possibly higher if corporate shareholder receives dividends, then distributes them again

Highest Marginal tax Rate

PartnershipS CorpC Corp

General Tax Differences



C Corp S Corp Partnership

Tax accounting. methods:

Personal Service Corporations (PSCs) and Qualified C corporation (i.e., annual gross receipts $5mm in 3 preceding years) may use cash, accrual or hybrid; non-qualified C corps must use accrual only.

Cash, accrual or hybrid (all three available, regardless of size).

Cash, accrual or hybrid, unless partner is a “non-qualified” C corporation. Then accrual method required.






Tax

administration

Easier to administer with centralized management. (However, conflicts of interest may arise between shareholders and management e.g., management may prefer tax methods that maximize earnings while shareholders may prefer tax methods that postpone earnings and taxes)

Complex if owned by many shareholders

Very complex. With no limits on # of general partners (GPs), large partnerships (P/Ss) would require very complicated tax administration. Also, IRS can now audit P/Ss at P/S levels; each partner (P) is put on notice to toll the 3 year statute of limitations

Subject to at-risk and passive activity loss (PAL) rules?

No, (except for personal holding companies or personal service corporations.)

Same as partnership

Yes, to P’s (except PALs do not apply if GP materially participates and business is a non-rental activity).




Selecting an Entity (Table 3)—Differences in Eligibility Among Entities

NoneOnly one class of common stock. Code Sec. 1361(b)(1)(D). However, differences in voting rights among common shares are OK

NoneCapital structure limits

NoneNone after 1996. Before 1997, could not own > 80% stock of another corporation

NoneAffiliate limits

NoneS corp. S/Hs allowed: Individuals Estates Qualified trusts

S corp. S/Hs NOT allowed: Nonresident aliens C Corporations Partnerships Banks Insurance companies

NoneOwner

identity limits

At least 21 to 100 (family members may elect to be treated as one). No Limit

# Owners

PartnershipS CorpC Corp

Eligibility Limitations:

Chapter 14, Exhibit 3


Selecting an Entity (Table 4)—Differences in Tax Treatment Among Entities

Entity Limitations


Entity Taxable year:

Any fiscal year end is OK.

Limited:

1. Calendar year; or

2. Business purpose satisfied if 25% gross rev. earned during last two month of adopted FYE during past 3 yrs. Code Sec. 1378;

Limited: Majority interest; or 5-Percenters; or Min. deferral rules; or Bus. purpose

Code Sec. 706.



Treatment of Equity Owner


Undistributed income

No tax to shareholder

Current tax Current tax

Current losses:

General

No deduction

Current deduction

Current deduction

Limit N/A Outside basis at risk Outside basis at risk

Character conduit

No Yes (Code Sec. 1366(b)).

Yes

Owner’s basis:

General

Constant (unaffected by corporate activity)

Adjusted annually Adjusted annually

Effect of entity debt

None None (neither basis nor AAA affected; only “at-risk” amount)

Outside basis AND at-risk amount affected (Code Sec. 752).


Selecting an Entity (Table 4)—Differences in Tax Treatment Among Entities


Corporation Defined

Either an organization incorporated under state law, or an unincorporated association that has “checked the box” for corporate tax treatment on Form 8832 (Entity Classification Election).

(Code Sec. 7701; Reg. §301.7701-1 to 3.)



Two Classifications of Corporate Entities C Corporations. Taxpaying entities. (This results in what is known as a

double tax effect. The corporation computes tax on the

net income When a corporation distributes its income, the corporation’s shareholders report dividend income on their own tax returns.)

S Corporations. Not subject to regular corporate income tax. They are

treated in a manner similar to partnerships, i.e., as pass-through entities, in that net profit or loss flows through to the owners to be reported on their separate returns.

Corporation Defined



C Corporations—Special Types

Professional Association [PA]. An association of professionals (e.g., accountants, doctors, lawyers) treated as a C corporation for tax purposes if it has:

Organized under a state’s Professional Association Act; AND

“Checked the box” on Form 8832 for corporate tax treatment. (One individual may be a professional association.)



Personal Service Corporation [PSC]. C corporation whose shareholder-employee(s) owns over 10% of the stock and provides personal services (e.g., acting, entertainment, medical, legal, consulting, or other services performed through their personal efforts.) Generally, a PSC must use a calendar tax year. (Code Sec. 441(i)). PSCs are subject to a flat 35% tax rate.




Personal Holding Company [PHC]. A non-exempt, closely held corporation, with a significant portion of its income that is passive in nature (e.g., from dividends or interest). PHCs are subject to a 15% penalty tax on excess personal holding company income in addition to the regular corporate income tax.




Q: When is a corporation deemed to be “closely held”?A: When more than 50% of the value of the outstanding stock was

owned by five or fewer individuals during the second half of the year.

Q: When is passive income deemed to be “significant”?A: When passive income is 60% or more of “adjusted ordinary

gross income (AOGI).” AOGI is gross income less capital gains and section 1231 gains, less adjustments such as certain expenses connected with rental and royalty income.




C Corporations—Tax Years

Every newly organized corporation other than a personal service corporations (PSC) has the unrestricted right to select its annual tax year, regardless of the tax years employed by its shareholders.

PSCs generally must use a calendar year-end. However, it may use a fiscal year-end under the same conditions as listed for S corporations.



Most corporations must use the accrual method.

The cash method MAY be used by C corporations that have average annual gross receipts of $5 million or less in the 3 preceding years, or by PSCs.

C Corporations—Accounting Methods



C Corporations—Tax Formula

Ord. and Cap. Income “From Whatever Source Derived”

– Exclusions

– Cost Of Goods Sold

= Gross Income

– Deductions

= Taxable Income (Loss)

x Tax Rate

= Gross Regular Tax Liability

– Credits (Including Prepayments)

= Net Regular Tax Liability

+ Alternative Minimum Tax (If Any)

+ FICA Taxes

+ Accumulated Earnings Tax (If Any)

+ Personal Holding Co. Tax (If Any)

= Net Tax Due or Refundable

Note: AGI, standard deductions, personal exemptions, at-risk rules, and passive activity loss rules do not pertain to regular C corporations.Chapter 14, Exhibit 9


C Corporations—Comparison with Individual Taxpayers

Income

Similar Treatment Different Treatment Most items of gross income receive the same tax treatment

Cost of goods sold (actually,

part of gross income) are similar

Bond Redemptions— Discounts

Sinking fund income



C Corporations—Comparison with Individual Taxpayers

Capital contributions Gain/loss on sale treasury stock Life Insurance Proceeds

Most exclusions receive the same tax treatment

Different TreatmentSimilar Tax Treatment

Exclusions



C Corporations—Comparison with Individual TaxpayersExpenses

Similar Tax Treatment Different Treatment Travel, meals, and entertainment Insurance premiums Research and experimental Fines (not deductible) Bad debts Worthless securities Casualty losses (same as individuals’ business use casualty losses) Taxes Depreciation (except Code Sec. 1250 recapture) Amortization Depletion Political contributions and lobbying Business investigation expense Business startup expense

Organizational expenditures Dividend received deduction Char. contributions Interest expense Amortization of original issue discounts Bond redemptions—prem. Stock redemptions (not deductible) Compensation Educational expenses Net operating losses Capital gains and losses Life insurance premiums on key-employees (firm is beneficiary)



Income Items Requiring Special Treatment

Bond RepurchasesA corporation’s income INCLUDES the original issue price of its own bonds being repurchased,

MINUS (i) The repurchase price, MINUS (ii) Any premium already recognized on the

original issuance. PLUS (iii) Any discounts previously deducted. Sinking Fund Income

Interest or other income from property in a sinking fund established to satisfy an obligation IS INCLUDED, even if in the hands of a trustee (since both funded and non-forfeitable).



Exclusions Requiring Special Treatment

Treasury Stock

No gain or loss is recognized by a corporation on the sale or exchange of its own stock.



Capital Contributions

Gifts from nonshareholders are excluded.

Noncash gifts. If a gift is property other than money, the corporation carries it with a zero basis.

Cash gifts. When cash is contributed, reduce the basis of corporate property in the following order:

(i) Property acquired within 1 year after the contribution;

(ii) Then depreciable property in proportion to relative bases;

(iii) Then, if there is a remaining balance, NON-depreciable property acquired over 1 year after the contribution.




Capital Contributions

Pro rata contributions from shareholders are excluded.

Whether voluntary or by assessment, shareholder contributions are excluded from corporate income. The corporation carries the property at the same basis as had been reported by the contributing shareholder. That shareholder gets no deduction, but does get an increase in stock basis, equal to the basis in the property contributed.




Deductions Requiring Special Treatment—Organizational Expenditures

Organizational expenditures. Expenses qualify for amortization if: (a) = Incurred incidental to formation of the corporation

(e.g., legal fees for drafting the charter, state incorporation fees, expenses for temporary directors and organizational meeting costs) and (b) = Incurred before the end of the tax year in which the corporation commences business.The first $5,000 of qualified expenditures are deductible in the year incurred (subject to a dollar-for-dollar phaseout once total expenses exceed $50,000). The remaining qualified expenditures must be amortized over 15 years, starting with the month that the corporation commences business.



Deductions Requiring Special Treatment—Organizational Expenditures

Nonamortizable expenditures. Organizationalexpenses DO NOT qualify for amortization if related to the transfer of assets to the corporation or the issuance and sale of stock. (e.g., printing stock certificates, professional fees for issuing stock and broker’s commission on the sales of stock). They are written off when the corporation completely liquidates.



Dividends Received Deduction—Example 1

“Affiliated” means owning 80% of both voting power and value of stock.

ATI = Revenue – COGS – Operating expenses + Other income.(Another way to arrive at ATI is to start with taxable income and purge out three possible deductions:

ATI = TI + (1) Actual DRD + (2) NOL carryover + (3) Capital loss carryback).

100% ATI 100% div. received ---80% & affiliated

80% ATI 80% div. received 80%20%

70% ATI 70% div. received 20%0%

<

Tentative* DRD Limit:* (Does not apply if DRD would create an NOL)

Tentative* DRD:* (Subject to DRD limit if DRD would

NOT create an NOL)

% Ownership

(Value & Voting)

DIVIDENDS RECEIVED DEDUCTION (DRD)

DIVIDENDS RECEIVED from other corporations are INCLUDED by both corporate and individual shareholders, but DEDUCTIBLE only by corporate shareholders within limits explained below.



FACTS: C Corp. has the following income and expenses:

Operating Revenue $ 800,000

COGS (300,000)

Operating expenses (520,000)

Other income (dividends received from a 25%-owned corp.) 100,000




SOLUTION: Note: The relevant DRD < 80% of stock.

Compute ATI (i.e., taxable income before special deductions.)

(a) = Rev. – COGS – Oper. exp. + Other inc.

ATI = $80,000

[= $800,000 – 300,000 – $520,000 + 100,000]

Determine tentative DRD limit.

(b) = 70% or 80% or

100% x ATI

Tentative DRD Limit = $64,000

[= 80% ATI = 80% x 80,000]

Compute tentative DRD.

(c) = 70% or 80% or

100% x Div. Rec’d

Tentative DRD = $80,000

[= 80% x $100,000]

Determine actual DRD (d) If(a) – (c) 0, then (d) = the lesser of (b) or (c)

If (a) – (c) < 0, then (d) = (c)

Actual DRD = $64,000

$80,000 ATI – $80,000 tentative DRD is 0; therefore, DRD = the lesser of:

(b) $64,000 tentative DRD limit, or (c) $80,000 tentative DRD

Compute TI (e) = (a) – (d) TI = $16,000

[= ATI – DRD = 80,000 - 64,000]

Compute tax (f) = (e) x appropriate tax rates

Tax = $2,400 [From tax tables: 15% x $16,000 = $2,400]





Note that in Example 1, the tentative DRD Limit applies since the DRD does not create an NOL. In Example 2, where operating expenses are $520,001 instead of $520,000, the tax results are much more favorable. An additional $1 of operating expenses saves $2,400 of taxes!

(a) ATI = $79,999 [= $800,000 – $300,000 – $520,001 + $100,0000]

(b) Tentative DRD Limit = $63,999 [= 80% ATI = 80% x $79,999 = $63,999]

(c) Tentative DRD = $80,000 [= 80% x $100,000]

(d) Actual DRD = $80,000 [Same as tentative DRD, since $79,999 ATI - $80,000 Tentative DRD is < 0.]

(e) TI = $(1), an NOL [= ATI – DRD = $79,999 - $80,000]

Tax = $0

FACTS: Same as Example 1 except operating expenses are $520,001, not $520,000.



Deductions Requiring Special Treatment—Charitable Contributions

Charitable contributions. As with individuals, corporate charitable contributions are deductible if made to qualified organizations. [i.e., Code Sec. 501(c) organizations]. Also, as with individuals, corporate contributions in excess of deductions are carried forward 5 years. No carrybacks are allowed for corporations or individuals.



The following DIFFERENCES distinguish corporate tax treatment from individual tax treatment:

10% ATI limitation. Deductions are limited to 10% ATI. What is ATI?

ATI for Charitable Deduction Computations.

= TI (i.e., after all deductions)

Addback:

+ DRD

+ NOL carryback

+ Capital loss carryback

+ Charitable deductions

Another way to compute ATI:

= Rev. – COGS – Operating expenses + Other income




2 ½ Month Rule. If a charitable contribution is board-approved in the current year and paid within 2 ½ months of the subsequent year, then a deduction is allowed in the current year. Not so for individuals. Inventory. Generally, as with individuals, corporations may deduct only the basis of inventory contributed. However, corporations may deduct the adjusted basis plus 1/2 of the appreciation (not to exceed twice the adjusted basis) if the inventory is donated solely for care of infants, the ill, or the needy.




SOLUTION: $43,000

1. ATI = $430,000 [$410,000 + $20,000]

2. 10% ATI Limitation = $43,000 [10% x $430,000 = $43,000]

3. Contribution = $45,000 [$40,000 currently + $5,000 carryover.]

4. Deduction = $43,000 [ < of 2. or 3.]

QUESTION: How much is the charitable deduction?

FACTS: C Corp.’s TI BEFORE the charitable deduction was $410,000. C Corp. contributed $40,000 to a qualified charitable organization. Included in the $410,000 is a $20,000 DRD. C Corp. also has a $5,000 carryover contribution from a prior year (not part of

the $410,000).

Charitable Contributions—Example



Deductions Requiring Special Treatment—Interest Expense and Original Issue Discount

Interest Expense. Interest expense on a corporation’s own debt is fully deductible, even if in connection with the repurchase of its own stock. Recall that individuals’ investment interest deductions are limited to net investment income. Not so with corporations.

Original Issue Discounts. OID is deductible as interest expense.

(1) Pre-7/1/82 issue bonds. Discount may be amortized using the straight-line method over the life of the bonds.

(2) Post-6/30/82 issue bonds. For bonds issued on or after 7/1/82, discounts from face value must be amortized using the effective yield method.



Example on OID, Post-6/30/82 Bonds (Effective Yield Method):

FACTS: 3/1/x1: A corporation hired an investment banking firm to underwrite and sell 5-

year, $10m bonds.

6/15/x1: The bonds were printed when the market yielded 10% on five-year bonds of comparable risk. Accordingly, the investment banking firm set the coupon rate at 10%.

6/15/x1 - 6/30/x1: The market yield on comparable five-year bonds rose to 12%. 6/30/x1: Five-year, $10,000, 10% bonds were issued to the public. Since the market

then yielded 12%, the bonds had to be discounted to $9,250 to be saleable.

QUESTION: How much OID is deductible on one $10,000 bond in 20x1 and 20x2?

SOLUTION: 20x1: $55.00; 20x2: $120.10 (i.e., $120.10 = $58.30 + $61.80)

Interest Expense and Original Issue Discount—Example



Interest Expense and Original Issue Discount—Example

SOLUTION (OID on Post-6/30/82 Bonds)

(a) (b) = (a) x 12% (c) =10m x 10%

(d) =

(b) - (c)

(e) = (a) + (d)

Year AIP, Beg Bal. *

x 12% yield Less: Interest Payment Deduction

OID Deduction

AIP, End. Bal. *

20x1

(2nd half)

9,250 555.00[9,250 x (12% x 1/2)]

500

[1,000 x 1/2]

55.00 9,3059,250 + 55 = 9,305

20x2

(1st half)

9,305 558.30[9,305 x (12% x 1/2)]

500 58.30 9,363

9,305 + 58.30 = 9,363

20x2

(2nd half)

9,363 561.80[9,363 x (12% x 1/2)]

500 61.80 9,425

9,363 + 61.80 = 9,425

* AIP = Adjusted Issue Price, the original issue price increased by the OID deduction.



Deductions Requiring Special Treatment—Bond and Stock Redemptions at a Premium

Repurchasing Bonds at a Premium. A corporation that repurchases its bonds may deduct as interest expense the excess of the repurchase price over the adjusted issue price.



Example on Repurchasing Original Issue Bonds at a Premium

FACTS: ABC Corporation buys back one $10,000 bond on 1/1/x1 at a repurchase price of $9,800. The adjusted issue price (AIP) on the bond is $9,425 as of 1/1/x1.

QUESTION: How much of the payment premium is deductible in the year 20x1 as interest expense?

SOLUTION: $375 (i.e., $9,800 payment, less $9,425 AIP balance)




Repurchasing Stock at a Premium. Amounts paid to repurchase stock are not deductible. Both acquiring and target corporations may capitalize legal fees, invest banker fees and other cost associated with a takeover.




Deductions Requiring Special Treatment—Compensation and Educational Reimbursement

Compensation. Four independent rules:

(1) Unreasonable compensation to a shareholder is generally treated as a dividend, to the extent of earnings and profits.

(2) Informal short-term arrangements. Payments made

by March 15 of the succeeding year may be accrued and expensed in the current year if related to services incurred in the current year.




(3) Executive Compensation Limitations. Deductible compensation for the top five executives of publicly traded companies is limited to $1,000,000 for each executive. Amounts exceeding this limit are deductible if determined via a performance-based compensation plan.

(4) Restricted Stock. Compensation to an employee in the form of stock is deductible when the employee reports the amount as ordinary income. Employees must include the market value of stock received for services in GI when (i) it is not subject to a substantial risk of forfeiture and (ii) its value is ascertainable.



SOLUTION:

20x1: No TI to employee; no deduction to employer.

20x7: $1,500 ordinary income to employee; $1,500 corporate deduction $1,500 [$2,000 - $500]

QUESTION: What is the timing and amount of the employee’s taxable income and the corporate employer’s deduction?

FACTS: 20x1: Employee purchases restricted stock (FMV = $1,000) from employer-corporation for $500. The stock is forfeitable until the employee serves the employer 6 years. 20x7: After 6 yrs., the restriction is lifted when the FMV = $2,000.

Example on Restricted Stock Compensation




Educational Expenses. An employer’s expenditures for employee education are deductible as business expenses. An individual, in contrast, may deduct only educational expenses required to maintain or improve skills in a present position.




Deductions Requiring Special Treatment—Rules for Net Operating Losses (NOLs)

Comparison of NOL Rules Between Corporations and Proprietorships

Corporations Proprietorships

Definition of NOL Excess business exp. over bus income

Same general definition as corporate.

Carryovers

[NOLs from tax years beginning after 8/5/97.]:

2 years back, 20 years forward. [For pre-8/5/97 NOLs: 3 yrs. back; 15 yrs. forward.]

Same as corporate





If carried backward Prior taxable income (TI) is recomputed, & taxpayer files for a refund with an amended return

Same as corporate.

If carried forward Deduction from gross income in a subsequent year

Deduction for AGI in a subsequent year






Election May elect to forego carrybacks Same as corporate

Calculation TI (a negative amount)

+ NOL Carryovers Deducted

= NOL

[Note that DRD is not added back; also net capital losses are not added back since they aren’t deductible in the first place.]

TI (a negative amount)

+ NOL Carryovers

+ Alimony deducted

+ IRA contributions

+ Nonbus. CL’s in XS of nonbus CG’s

+ Std. or itemized deductions, except personal casualty deductions are not added back.

+ Personal exemptions

- Interest income

- Dividend income

- Nonbus. CG’s in XS of nonbus CL’s

- Other nonbusiness inc. (except wages are not subtracted.)

= NOL




Unlike individuals, corporations need not make adjustments to NOL for capital gains or losses. Also, corporations are permitted the full DRD in computing NOLs.




Net Operating Losses (NOLs)—Example

FACTS:

1. Fred Corporation had $100,000 sales and $135,000 expenses, plus a

$(30,000) NOL carryover from 20 years ago.

2. Fred Corporation also had the following income and expenses:

(a) $1,000 interest income on a savings account;

(b) $70,000 dividends from a 30% - owned corporation;

(c) $1,500 LTCG on the sale of business property;

(d) $(10,000) STCL on the sale of stock;

(e) $ 9,000 LTCG on the sale of a painting held for investment;

(f) $ (6,000) charitable contributions.

QUESTION: Compute Fred Corporation’s NOL.



Net Operating Losses (NOLs)—Example


$ (20,150) NOL =

30,000 NOL carryover +

$ (50,150) TI

NOL = $(19,500):

$ (50,150) Taxable income =

10% ATI where ATI = ($35,000) + $1,000 + $70,000 + $500 – $30,000 = $6,500

(650) Charitable deductionThe lesser of: (1) $6,000; or (2) 10% ATI

–

$1,500 – $10,000 + $9,000 500 Net LTCG +

80% x $70,000 (56,000) DRD –

70,000Dividends received +

1,000Interest income +

(30,000) NOL carryover –

$100,000 – $135,000 = (35,000) $ (35,000) Operating loss

Taxable Income = $(53,150):


Deductions Requiring Special Treatment—Capital Gains and Losses

Comparison Between Corporations and Individuals

Corporations Individuals

Determining long/short-term capital gains/losses:

Requires netting from a single “rate basket”

Requires netting among several “rate baskets”

Tax on net long-term capital gains

Ordinary corporate tax rates

Ord. ind’l rates, up to 10%/15%/20%/28%

Tax on net short-term capital gains

Ordinary corporate tax rates

Ord. ind’l tax rates, no limit

Net long-short-term capital losses

Not deductible Deductible up to $3,000 ($15,000 if married filing separately.)





Corporations Individuals

Carryovers 3 yrs. back, 5 yrs. fwd. (Unlike with NOLs, no election allowed to forgo carrybacks.)

Carry forward (not back) indefinitely

Character of capital loss carryovers

Long and short-term capital losses carried over as short-term

Long/short-term loss carryovers retain their character




Net nonbusiness capital losses are added back to taxable income (TI).

(Note that they are always $3,000);

Net nonbusiness capital gains are subtracted from NBD to determine the adjustment for NBD in excess of NBI.

Net capital losses are never part of NOL since they are not deductible. Therefore, no addback to taxable income (TI).

Net capital gains are not subtracted from TI (i.e., capital gains reduce NOLs).

Computing NOL

Individuals Corporations




Deductions Requiring Special Treatment—Depreciation Expense

Depreciation Including Sect 179. Generally, the rules for corporations are identical to the rules for proprietorships. However, for Code Sec. 1250 assets, an additional recapture amount is required under Code Sec. 291:

Code Sec. 291 Exception for Corporations. For corporations, realized gain must be characterized as Code Sec. 291 ordinary income (OI) to the extent of 20% of any excess of “pretend” Code Sec. 1245 OI over Code Sec. 1250 OI.



FACTS:

1/1/x1: ABC Corp. acquired an office building for $450,000.

1/1/x1 - 12/31/13: The building was depreciated using 15-year straight-line.

1/1/14: The building was sold 13 years later for $240,000.

QUESTION: Compute Code Sec. 291 OI and Code Sec. 1231 gain.

Depreciation Expense—Example



180,000 - 36,000 144 Code Sec. 1231 cap. gain (j) = (e) - (i)

180,000 x 20% 36 Code Sec. 291 OI (i) = (h) x 20%

180 Excess “pretend” Code Sec. 1245 OI

(h) = (f) - (g)

“$0” since ACRS (i.e., accelerated depreciation) was not used.

0 OI under Code Sec. 1250 (g)= Excess accel depr over S/L depreciation.

Lesser of 390m or 180m 180 “Pretend” Code Sec. 1245 OI (f)= < of (c) or (e)

180 Realized gain (e)=(a)-(d)

60 Adjusted Basis (d)=(b)-(c)

(450m 15 years) x 13 yrs, (ignoring mid-month convention)

390 Accumulated Depreciation (c)

450 Cost (b)

Adjusted Basis

240 Sales Price (a)

Computations000’s Description Formula

SOLUTION

Depreciation Expense—Example



Reconciling Book and Taxable Income

Form 1120. A corporation files its federal return on Form 1120.

Schedules M-1 and M-3. Reconciling accounting and tax income is done on Schedule M-1 of Form 1120. M-1 and M-3 address differences, both permanent and temporary, between accounting and tax income. The differences are caused by using different accounting and tax methods to report income and expenses. In addition to tax reporting, M-1 and M-3 are also useful for tax planning.



Example on M-1 Reconciling Items:

FACTS:

ABC Corp. reports the following results of operations:

Net income per books, after taxes $88,000

2003 rent received in advance (booked as a liability) 11,000

Federal income taxes 13,750

Tax-exempt interest on Municipal bonds 3,000

Net capital loss (in XS of CGs) 1,250

Premium paid on life insurance for key employees (ABC = Beneficiary)

1,000

Life ins. proceeds received due to death of key employee 10,000

XS MACRS over S/L depreciation (S/L is used for accounting purposes.)

5,000

Charitable contribution carryover from a prior year $ 7,000




Prepare an M-1 reconciliation and compute taxable income

Net income per books $ 88,000

+ Expenses per books that are not deductible:

Federal income tax expense (not tax deductible) 13,750

XS capital losses over capital gains (not tax deductible) 1,250

Insurance premiums (not deductible since ABC is a beneficiary) 1,000

– Deductible expenses not booked for accounting purposes

XS MACRS depreciation per tax return over S/L depreciation per books (5,000)

Charitable contribution carryover from a prior year (7,000)

– Income per books not taxable

Tax-exempt interest on municipal bonds (3,000)

Life insurance proceeds received on death of key employee (10,000)

Taxable income not booked for accounting purposes

+ Future rent received in advance 11,000

= Taxable income $ 90,000




Corporate Tax Rates

Computing Regular Income Tax. Corporations are subject to the 4-bracket graduated tax rate structure below.

Tax Rates on Corporate Taxable Income

At Least: But Not Over: Marginal Tax Rate:

$ 0 $ 50,000 15% (1st bracket)

50,000 75,000 25% (2nd bracket)

75,000 100,000 34% (3rd bracket)

100,000 335,000 39% (3rd + 5% surcharge)

335,000 10,000,000 34% (3rd bracket)

10,000,000 15,000,000 35% (4th bracket)

15,000,000 18,333,333 38% (4th + 3% surcharge)

Over 18,333,333 35% (4th bracket)



Surtaxes imputed in the previous table. A 5% surtax is charged on TI between $100m and $335m, which

eliminates the “tax savings” on the first $100m of TI. A 3% surtax is charged on TI between $15,000,000 and $18,333,333,

which recaptures the “tax savings” from $335,000 to $10,000,000.

Capital gain rates. Same as ordinary rates. No rate breaks as with individual tax rates.

Capital losses. Not deductible as with individuals, offset only against capital gains.

Corporate Tax Rates



Personal Service Corporations. Taxed at a flat rate of 35% on all taxable income (TI).

Controlled group of corporations. Rates are applied to the aggregate TI of the group as if it were a single corporation. A controlled group a parent corporation and one or more subsidiaries in which the parent owns EITHER: (a) 80% total voting power of Subsidiary, or (b) 80% total value of Subsidiary’s stock.Any additional corporation with an 80% connection to any member of the controlled group becomes part of the controlled group.

Corporate Tax Rates



Corporate Tax Credits

General Availability of Credits. Most tax credits available to individuals are available to corporations. Exceptions include:

Earned income credit; Child and dependent care credit; Elderly and disabled credit; Hope credit; Lifetime Learning credit; Adoption credit.




Foreign Tax Credit (FTC) Or Deduction (FTD). A U.S. citizen or resident alien may elect either a credit or a deduction “FOR” AGI, on taxes paid to other countries or U.S. possessions. The maximum amount credited or deducted is determined from the table below.

Template for Computing the Foreign Tax Credit/Deduction

(a) U.S. income tax before the foreign tax credit or deduction.

(b) Foreign source taxable income (TI).

(c) Worldwide taxable income.

(d) = (a) x [(b) (c)] Allocation amount.

(e) Foreign taxes actually paid on worldwide TI.

(f) = < (d) or (e) Foreign tax credit or deduction.




FTCs are credited against gross tax liability before all other credits. FTDs are deductible from gross income. FTC’s usually result in greater tax benefits than FTDs. Unused foreign tax credits or deductions are carried back one year

and then carried forward ten years. For NON-RESIDENT ALIENS, FTC is allowed to reduce U.S. tax

on U.S. income but only to the extent that foreign taxes have been paid on U.S. income.



Corporate Tax Credits—Example


QUESTION: What is U.S. Corp.’s FTC or FTD?

34,000Foreign tax credit or deduction(f) = < (d) or (e)

45,000Foreign taxes actually paid on worldwide TI (e)

34,000Allocation amount(d) = (a) x [(b) (c)]

500,000Worldwide taxable income (c)

100,000Foreign source TI (b)

(a)

SOLUTION:

FACTS:

U.S. Corp. has worldwide TI of $500,000, and a tentative U.S. tax liability of $170,000. From its Chinese operations, U.S. Corp. had $100,000 of TI on which a $45,000 Chinese tax was paid.

$ 170,000U.S. income tax before the FTC or FTD


Consolidated Returns

Election To File Consolidated Return. A parent-subsidiary controlled group (but not a brother-sister controlled group) has two basic alternatives for filing Form 1120:

Separate returns; or Consolidated returns.




Regulated investment companies Domestic International Sales Corps Corps. claiming the Code Sec. 936 possess. tax credit

S corporations Foreign corporations Tax-exempt corporations Real Estate Investment Trusts Insurance corporations

Types of Corporations That May Not Consolidate. The following corporations may not file consolidated returns:



Code Sec. 1231 gains and losses Capital gains and losses % depletion of mineral

properties

Charitable contribution deductions Div.-received and -paid deductions NOL deduction

Items Which Are Consolidated Separately. The rules and regulations pertaining to consolidated returns are very complex, covering several volumes. Briefly, the following items must be consolidated separately:




Consolidated Returns—Example


QUESTION: What amounts should be reported on the 20x1 and 20x2 consolidated returns?

SOLUTION: 20x1: $0; 20x2: $65 LTCG.

FACTS: Parent files a consolidated return with Subsidiary. In 20x1, Parent sells land to Subsidiary for $100 when it was worth $75. Parent had a $60 basis in the land. In 20x2, Subsidiary sells the land to an unrelated third party for $125. During 20x2, Subsidiary pays a $20 dividend to Parent.


Consolidated Returns—Example

Dividends. A dividend distributed by one member of a group filing a consolidated tax return to another member of that group is eliminated. The recipient of the dividend makes an adjustment to its separate TI that eliminates the dividend from the affiliated group’s consolidated TI. DRD does not apply to inter-group dividends of affiliated groups that file a consolidated return.

Sale of land. In 20x1, Parent recognizes a LTCG of $15 (75 - 60) and Subsidiary recognizes a $50 gain (125 - 75). A sale or exchange of property between members of an affiliated group is a deferred intercompany transaction. Gain is not reported until the property is sold outside the group in 20x2. Also, amount realized may not exceed FMV in a related party transaction.



Estimated TaxesDates of payments. Estimated tax payments must be made by the 15th of the 4th, 6th, 9th and 12th months of the tax year. For calendar-year corporations, quarterly payments are due by April 15, June 15, September 15 and December 15. (Same as for individuals, except that individuals file the fourth payment by January 15 of the following year, instead of December 15 of the current year.)

Minimum quarterly amount. = 25% of the lesser of (a) or (b) where:

(a) = 100% of prior year tax;(b) = 100% of current year tax.

(i) > $1 million exception: A corporation with taxable income over $1

million during any of the 3 preceding years must pay quarterly installments on 100% of the current year’s tax, without regard to prior year tax.

(ii) < $500 exception: If the tax liability shown on the return is below $500, estimated tax payments are not required (i.e., no estimated tax

penalty is imposed on underpayment).



Accumulated Earnings Tax (AET)

The AET is imposed only on a corporation that:

Is NOT a personal holding company; and, Allows earning and profits to accumulate instead of

being distributed, for the purpose of avoiding income tax at the shareholder level.

The AET penalty tax rate 15% and is in addition to the regular income and AMT



Personal Holdings Tax (PHC)

The main reason for the PHC tax is to prevent an individual from transferring dividend-paying investments into a corporation and then using the DRD to avoid taxable income. The PHC tax is imposed on any corporation that has both of the following conditions:

Not more than 5 stockholder own over 50% of the total stock based on market value; and

At least 60% of adjusted ordinary gross income is passive.

A personal holding company is not subject to the AET.

The PHC penalty tax rate is 15% on undistributed personal holding company income, and is in addition to the regular corporate tax.



Formation of C Corps, S Corps and Partnerships—Owner Perspective

FORMATION C and S Corporations Partnerships

Control requirement for tax-free treatment

80% control after exchange

No control requirement

Tax treatment for services contributed in exchange for ownership

Always ordinary income

Always ordinary income




Formation C and S Corporations Partnerships

How is an owner’s recognized gain or loss on “tax-free” formation determined?

Gain = Lesser of (a) or (b): (a) = Realized gain; (b) = Boot rec’d, where boot is any property received other than common stock. Debt relief is also boot to the extent it exceeds the basis of all property contributed.Realized losses are never recognized in a Code Sec. 351 exchange; realized losses are always recognized in a non- Code Sec. 351 exchange.

Disguised sale rules:

Gains: Yes; Losses: Yes except losses are not recognized if the disguised sale involving a 50% + partner.

Recognized Gain or Loss = [(a) - (b)] x [(c) (a)], where,

(a) = FMV of P/S interest received;

(b) = AB of property contributed; (c) = FMV of other property received within two years of new ownership.

[Note: (a) - (b)] = realized gain.





What is an owner’s basis in the ownership interest?

The following formula applies to both tax-free and taxable exchanges: AB in corp. stock =

+ AB in contributed prop.;

+ Shareholder’s recog. gain;

– FMV of boot rec’d, including debt relief that is boot;

– Debt relief that is not boot;

– Shareholder’s recog. loss.

AB in P/S interest =

(b) x {[(a) - (c)] (a)}, where (a) = FMV of P/S interest

received;

(b) = AB of property

contributed; (c) = FMV of other property received within two years of new ownership.





What is an owner’s holding period (HP) in the ownership received?

Same as property contributed. Split HPs may be necessary.

Same as property contributed. Split HPs may be necessary.

What is an owner’s basis in property other than equity received from an entity?

Same as the corporation’s adjusted basis (not FMV, as in like-kind exchanges).

FMV of prop. received. (Plus postponed loss in the rare case of a 50%+ owner who postpones a realized loss on a disguised sale)

What is an owner’s holding period in property other than equity received from an entity?

HP begins on the day AFTER receipt.

HP begins on the day AFTER receipt.



Formation of C Corps, S Corps and Partnerships—Entity Perspective


What is an entity’s basis in property contributed by a new owner?

Basis in property = (a) + (b), where,

(a) = Shareholder’s basis in contributed property;

(b) = Shareholder’s recognized gain (if any).

Basis in property =

(c) + {[(a) - (c)] (a)] x (b)}, where,(a) = FMV of P/S interest received;

(b) = AB of property contributed;

(c) = FMV of other property received within two years of new ownership.

Does an entity recognize gain or loss on the exchange of an ownership interest for property in a tax-free exchange?

No, never. No, never.



Formation of C Corps, S Corps and Partnerships—Entity Perspective


Does an entity compute recognized gain or loss on the exchange of property other than equity to new owners?

Gains: Yes; Losses: No.

Gain = [greater of: (a) or (b)] – (c):

(a) = FMV of prop. distributed;

(b) = Corporation’s debt relief (if any);

(c) = Corporation’s basis in property distributed.

Gains: Yes; Losses: Yes, except losses are not recognized if the disguised sale involves a 50% + partner.

Gain or loss =

[greater of: (a) or (b)] – (c):

(a) = FMV of prop. distributed;

(b) = P/S’s debt relief (if any);

(c) = P/S’s basis in property distributed.



Formation of Corporations—Overview of Code Sec. 351

What is the general rule on transferring property to a corporation in exchange for stock?

Code Sec. 351 requires that no gain or loss is recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in the corporation and immediately after the exchange, such person or persons control the corporation. This non-recognition treatment is mandatory, not elective. Note that Code Sec. 351 protects only the transfer of property. It does not protect the transfer of services. Also, Code Sec. 351 applies even after a corporation has been formed.




What was Congress thinking when it enacted Code Sec. 351?

There are two reasons for Code Sec. 351. First, as the stockholders receive only stock, they may not have the wherewithal to pay taxes. Second, the incorporation of a going concern is not an economic transaction but rather a change in legal form only.




What is “control”?

Control is ownership by all transferors of property of 80% or more of BOTH the voting power AND the value of all classes of stock. Do not include the % ownership of transferors of services in this determination.




What is “property”?

Consistent with Code Sec. 351(d) “property” includes just about everything except services (i.e., cash, inventory, receivables, land, other tangible assets, nonexclusive licenses and industry know-how).




Why are “services” NOT “property’?

Under Code Sec. 351(d)(1), services are NOT property to ensure that a person who provides ONLY services to a corporation (1) will be taxed immediately (on the FMV of stock received); and (2) will NOT be included in the 80% control computation.

Chapter 14, Exhibit 38e



How does Code Sec. 351 apply if a person contributes both property and services?

The receipt of stock attributable to services will generally be treated as a separate transaction outside the scope of Code Sec. 351. [However, the stock received in exchange for part property, part services will ALL be included in the 80% control computation!]

Chapter 14, Exhibit 38f


Code Sec. 351 Contribution of Part Property/Part Services—Example


FACTS:

A transfers land worth $50,000, and B transfers land worth $15,000 and contributes services worth $35,000 to X Corp. in exchange for all of the stock of X.

QUESTION 1: Has the 80% control requirement been met under Code Sec. 351?

SOLUTION 1: Yes, B’s stock attributable to services counts in the “control” computation—and control by A and B after the exchange is 100%. Since control immediately after the exchange 80%, the exchange qualifies as a Code Sec. 351 exchange.

CCH Federal Taxation Comprehensive Topics 94 of 115Chapter 14, Exhibit 39b

QUESTION 2: What would be the result if B contributed ONLY services?

SOLUTION 2: Then B’s stock would not count in the control computation, and control immediately after the exchange would be limited to A’s 50%. Since 50% < 80%, this would not have been a Code Sec. 351 exchange.


CCH Federal Taxation Comprehensive Topics 95 of 115Chapter 14, Exhibit 39c

QUESTION 3: Can B get Code Sec. 351 tax free treatment for the $35,000 services contributed?

SOLUTION 3: No, services are not property under Code Sec. 351(d)(1). Therefore, B will recognize $35,000 OI as compensation for his services.



Code Sec. 351 Contributions—Tax Effect on Shareholders

What is the recognized gain of shareholders in a Code Sec. 351 transfer of property for stock?

Code Sec. 351(b) provides that a shareholder’s recognized gain will be the smaller of (1) boot received or (1) realized gain. (Students should not confuse Code Sec. 351 boot with Sec. 1031 “net boot received”—that term applied to like-kind exchanges under Code Sec. 1031) Here, boot is money and the FMV of property other than the common stock of the corporation received in the exchange. Also, under Code Sec. 358(c), a shareholder liability assumed by the corporation is boot if it exceeds the AB of all property contributed by the shareholder. If not, then it’s not boot.



How is the basis of the stockholder in the stock determined? Code Sec. 358 provides the following formula (referred to as the “front-in” approach):

AB in contributed property– Fair market value of boot received, including liabilities assumed by

corporation that ARE boot– Liabilities of shareholder assumed by corporation that are NOT boot.

Code Sec. 358(d)+ Gain recognized by the shareholder– Loss recognized by the shareholder= SHAREHOLDER BASIS OF STOCK




How is a shareholder’s holding period in the stock determined?

The holding period of the property contributed tacks on to the stock received. If several properties have been contributed, the stock will have a split holding period!




What is a shareholder’s basis and holding period in the boot received?

The shareholder’s basis in boot received is generally the corporation’s basis (not FMV). The holding period of boot received does not tack on as does stock received. Instead, it begins on the day AFTER receipt.




Code Sec. 351 Contributions—Tax Effect on Corporations

What is the corporation’s basis in the assets transferred byshareholders?

Code Sec. 362 provides that the basis of assets received by a corporation in a Code Sec. 351 transfer will be (a) + (b), where:

(a) = Shareholder’s basis in contributed property(b) = Gain recognized by the shareholder, allocated using

relative fair market value’s.(a) = (a) + (b) = Corporation’s basis in assets contributed by

shareholders



What is the corporation’s holding period in the assets contributed by a shareholder?

Same as the holding period of the shareholder.

Does the corporation recognize gain or loss on the exchange of its stock for property under Code Sec. 351?

No, never.

What about property other than stock transferred by the corporation? If a corporation transfers other property to shareholder, then YES, it generally recognizes gain (but not loss) based on [FMV - AB].

Code Sec. 351 Contributions—Tax Effect on Corporations



Code Sec. 351 Contributions—Example 1

Facts: On 12/31/x1, Dennis forms a new corporation and receives 100% of the corporation’s stock after contributing the following property:

Land Building

Holding period Began 3/21/97 Began 8/19/x1

FMV, 12/31/x1 1,000,000 14,000,000

Basis, 12/31/x1 2,000,000 3,000,000

Bldg. mtg.assumed by corporation

6,000,000



Question: Compute the following items:

Dennis’ realized gain Dennis’ boot received Dennis’ recognized gain Dennis’ postponed gain Dennis’ basis in the stock received Dennis’ holding period in the stock received The corporation’s basis in the land and building contributed

by Dennis The corporation’s holding period in the land and building




4 Note: Dennis’ stock is not publicly traded. However, its value may be assumed to be equal to the net value of assets received by the corporation:

FMV of land………………....... 1

+ FMV of bldg..........…….......+ 14

– Mtg. assumed by corporation …(6)

= Net value of assets .(i.e., Dennis’ amount realized) ………………9

– Basis of contributed property

(2mm land + 3mm bldg)….. 5

= Dennis’ realized gain............…. 4

(a) = Amount Realized


= Realized gain

(Similar to rules for any disposition)

Dennis’ realized gain:

000’sComputation FormulaSolution:




1 Dennis’ debt relief.……………... 6


(2mm land + 3mm bldg)……...... (5)

= Excess debt relief.…………...... 1

+ FMV of other boot received...... 0

= Dennis’ total boot received....... 1

(b) = Excess debt relief (i.e., debt relief—AB of assets contributed)

+ FMV of other boot received

Dennis’ boot received





1 (a) = 4,000,000

(b) = 1,000,000

(c) = 1,000,000 (the lesser amount)

(c) = Lesser of (a) or (b)

(Similar to “like-kind” exchange rules)

Dennis’ recognized gain:

000’sComputationFormulaSolution:


Chapter 14, Exhibit 42e

Note: See previous slides for values.



3 (d) = $4,000,000 – $1,000,000 = $3,000,000

(d) = (a) – (c)Dennis’ postponed gain:


Chapter 14, Exhibit 42f

Note: See previous slides for values.


Back-in approach:

(Here, the stock’s FMV must first be “plugged” from amount realized):

FMV of stock:

Amt realized………9

- Debt relief………(6)

= Stock FMV…… 3

Stock basis:

Stock FMV……. 3

-Postponed gain…. (3)

= Stock basis…….. 0


0 Front-in approach:

Stock basis:

+ AB in cont’d

property……… 5

- Boot rec’d……..(1)

- Debt relief,

nonboot (6-1)….(5)

+ Gain recog’d…..1

- Loss recog’d….. 0

= Stock basis …... 0

Dennis’ stock basis can be determined two ways:Using the Code Sec. 358 formula, i.e., the “front-in” approach (shown above)Using the “back-in” approach, as was done for like-kind property received

Dennis’ basis in the stock received:


Chapter 14, Exhibit 42g



HP of 1/15 share begins on 3/21/97; HP of 14/15 share begins on 8/19/x1. (Thus, as of 12/31/x1, 1/15 of each share is deemed to be long-term, and 14/15 short-term!)

(f) = Same as holding period of the contributed property

Note 1. Since more than one property was contributed for the stock, each share will have a split holding period (HP).Note 2. The HP rules for Code Sec. 351 stock is similar to HP rules for like-kind assets received under Code Sec. 1031.

Dennis’ holding period in the stock received:


Chapter 14, Exhibit 42h



Chapter 14, Exhibit 42i

3,000,000

933,333

3,933,333

2,000,000

66,667

2,066,667

Dennis’ asset basis

+ Alloc. of recog. gain:

1 mm x [ 1 (1 + 14)]

1 mm x [14 (1 + 14)]

Corporation’s basis


Bldg. Land The corporation’s basis in the land and building can be determined using the Sec. 362 above.

The corporation’s

basis in the assets

received:



Chapter 14, Exhibit 42j

(Same as Dennis’ HP)

8/19/x1 3/15/97 HP beginning date


Bldg. Land (h) = Same as shareholder’s HP

The corporation’s holding period in assets received:



The fair market value of the stock is $1,000 per share. Ellsworth’s land is subject to a $10,000 mortgage which the corporation assumed.

100$110,000TOTALS

1011,00010,000EquipmentTebessum

6020,00070,000LandEllsworth

30 $ 0 $ 30,000 Services Anu

# shares issued AB to S/H FMV Asset Stockholder

FACTS:

Anu, Ellsworth and Tebessum decided to pool their efforts and form a corporation. They made the following contributions to the corporation:



SOLUTION 1: No, Anu is not a transferor of property. Only Ellsworth and Tebessum can be included in the control computation. Since their combined control is only 70% [(60 + 10) 100], the 80% control requirement has not been met. What would be the result if Anu had also contributed $1.00? Answer would be the same. Anu would have to contribute an asset with a FMV of at least 10% of the value of the services.

QUESTION 1: Does this transfer of assets qualify for Code Sec. 351 treatment?




QUESTION 2: Assuming that Anu also contributed an asset in the previous transaction that the transfer did qualify under Sec. 351, fill in the blanks below. (Answers provided.)

SOLUTION 2:

Stockholder Realized G/L

(FMV – AB)

Recog. Gain/Loss

(< Real gain or boot rec’d)

Basis of stock

(AB - debt relief + recog’d gain - recog’d

loss)

Anu $30,000

($30,000 – 0)

$30,000

(services income)

$30,000

(0 – 0 + $30,000)

Ellsworth $50,000

($70,000 – $20,000)

0

($0 boot received)

$10,000

($20,000 – $10,000 + 0)

Tebessum ($1,000)

($10,000 – $11,000)

0

($0 boot received)

$11,000

($11,000 – 0 + 0)

Basis of the land to the corporation: $20,000. (Ellsworth’s AB of $20,000 + $0 gain recognized by Ellsworth)




QUESTION 3: Assuming the previous transaction did NOT qualify under Code Sec. 351, fill in the blanks below. (Answers provided.)

SOLUTION 3:

Stockholder Realized G/L

(FMV - AB)

Recog. Gain/Loss

Basis of stock

(AB - debt relief + recog’d gain - recog’d loss)

Anu $30,000 $30,000 $30,000

(0 - 0 + $30,000)

Ellsworth $50,000 $50,000 $60,000

($20,000 – $10,000 + $50,000)

Tebessum ($1,000) ($1,000) $10,000

($11,000 – 0 + $1,000)



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