Deck 2: Corporate Formation and Capital Structure

Question 1

L and R each want to start their own business.L transfers $500,000 to his corporation for shares of stock and a note bearing 10 percent interest, the interest being payable in annual installments of $50,000 for 20 years.R transfers to his corporation $500,000 solely in exchange for stock.Both wish to receive $50,000 from their corporations at the end of the first year.L receives a $50,000 interest payment and R receives a $50,000 dividend.On their individual returns L and R will report ordinary income of $50,000, but only L's corporation can claim a $50,000 deductible expense.

Answer 1

True

Question 2

T Corporation transferred $75,000 to a newly formed corporation in exchange for stock.At the time of the contribution, the new corporation's total capital was $500,000.T Corporation's stock qualifies as § 1244 stock.

Answer 2

False

Question 3

B owns 85 percent of the stock of D Corporation, and C owns the remaining 15 percent.The corporation has been in operation for three years.During the year, B transferred land worth $20,000 (basis $11,000) to the corporation for additional shares, increasing his ownership to 88 percent.B is not required to recognize gain on the transfer.

Answer 3

True

Question 4

The holding period of stock received in an exchange qualifying for nontaxable treatment under § 351 begins on the date the transferred asset was acquired, assuming the asset was a building used in the transferor's sole proprietorship.

Question 5

Transferor contributed $120,000 to a newly formed corporation in exchange for stock.At the time of the contribution, the corporation's total contributed capital was $5 million.Transferor's stock qualifies as § 1244 stock.

Question 6

Holder contributed $50,000 to a newly formed corporation in exchange for § 1244 stock.During the year, he sold the stock to Buyer.The stock qualifies as § 1244 stock in Buyer's hands.

Question 7

An individual provides accounting services to a corporation in exchange for stock.The shareholder must recognize income and the corporation may deduct or capitalize the expenditure as would be appropriate.

Question 8

A court decision that recharacterizes a corporation's debt obligations as stock normally would result in unfavorable tax consequences for an individual holding the purported debt.

Question 9

J owns all 150 shares of stock of Y Corporation, worth $500,000.This year he convinced his son K to come into business with him.To this end, K contributes appreciated property worth $100,000 (basis $5,000) to the corporation for 50 shares of Y stock.K should recognize no gain on the transfer, assuming his father also transfers cash of $25,000.

Question 10

Transferor contributed $180,000 of cash to his newly formed corporation in exchange for stock.As part of the same plan, Manager received $20,000 of stock for services to be performed during the first year of business.Manager's stock qualifies as § 1244 stock.

Question 11

J formed X Corporation during the year by transferring land worth $50,000 to the corporation in exchange for all of its stock.The property had a basis of $20,000 and was subject to a mortgage of $15,000, which the corporation assumed.As a general rule, J must recognize gain of $15,000.

Question 12

Assuming both investments become worthless after three years, a married individual investing in a corporation would be indifferent to whether he receives a $20,000 note or $20,000 of § 1244 stock in exchange for a $20,000 transfer.

Question 13

N established L Corporation by transferring property worth $100,000 (basis $25,000) to the corporation for all of its stock.N's basis in the stock received is the same as the corporation's basis for the property, $25,000.

Question 14

During the year, R and S established T Corporation, which issued 100 shares of stock.R transferred land worth $9,000 (basis $8,000) to the corporation for 90 shares of stock while S contributed services worth $1,000 for 10 shares of stock.Neither R nor S must recognize income due to their respective transfers.

Question 15

P formed Y Corporation by transferring property worth $70,000 to the corporation for all of its stock.The property had a basis of $30,000 and was subject to a mortgage of $10,000.P's basis in her stock is $20,000.

Question 16

M incorporated her proprietorship this year.After receiving all of the stock of her new corporation, she immediately transferred 30 percent of the stock to her sister.M's exchange is not taxable even though she retained control only briefly after the exchange.

Question 17

If a corporation receives a nonshareholder contribution representing an inducement rather than payment for corporate goods or services, the corporation must include the transfer in gross income.

Question 18

G owns 85 percent of the stock of X Corporation, and H owns the remaining 15 percent.The corporation has been in operation for three years.During the year, G transferred land worth $20,000 (basis $11,000) to the corporation for a note bearing 10 percent interest and maturing in 15 years.G is not required to recognize gain on the transfer.

Question 19

During the year, Proprietor incorporated his hobby shop in a transaction that generally qualifies for nonrecognition under § 351.As part of the formation, he transferred various liabilities to the new corporation, including a bill for a recent shipment of Prestochangos, the hottest toy on the market.When the corporation later paid the bill, it properly charged the items to its inventory account.In determining the tax consequences of exchange, the liability is ignored for determining Proprietor's gain recognized.

Question 20

Contributor transferred $50,000 to his newly formed corporation in exchange for § 1244 stock.During the year, he gave some of the stock to his son who will someday own the entire business.The stock qualifies as § 1244 stock in the son's hands.

Question 21

Several years ago, Theodore Theory started his own company for manufacturing peripheral equipment such as memory chips and boards.This year he transferred all of the assets and liabilities of his high-tech business, worth $10 million, to a newly formed corporation in exchange for 10 percent of its stock.The other transferor was a large conglomerate that contributed the assets of its technology division, worth $90 million, to the corporation in exchange for 90 percent of the stock.Theo retired to Florida and followed his investment in The Wall Street Journal while the conglomerate took over total control of the new enterprise.Which of the following statements is true?

A)Theo should qualify for nonrecognition under § 351 in this situation, since the transaction meets its literal requirements and is consistent with the policy underlying the provision.
B)Theo will qualify for nonrecognition under a literal interpretation of the Code even though the application of § 351 in this situation is inconsistent with the policy underlying the provision.
C)Theo will not qualify for nonrecognition in this situation under § 351, since he has neither met the literal requirements of the provision nor satisfied the policy underlying the law.
D)Although application of § 351 is consistent with the policy underlying the provision in this situation, Theo will not qualify for nonrecognition because he has not met the provision's literal requirements.

Question 22

T Corporation was formed 10 years ago by J, K, and L.These three shareholders currently own all of the corporation's stock as follows: J owns 500 shares, K owns 100 shares, and L owns 100 shares.This year J contributed property worth $90,000 (basis $20,000) to the corporation in exchange for an additional 300 shares.J will

A)Recognize gain on the exchange because on the exchange he received only 30 percent of the stock outstanding after the exchange
B)Recognize gain because the transfer is not to a newly formed corporation
C)Recognize no gain because transfers to a corporation by a shareholder in exchange for a stock interest are nontaxable regardless of the transferor's stock ownership
D)Recognize no gain because he has sufficient stock ownership after the exchange

Question 23

S transfers land to a new corporation for stock.The corporation plans to issue 1,000 shares of voting common stock and 500 shares of nonvoting preferred stock.Common stock notwithstanding, the minimum number of preferred shares that S must receive to be in control is

A)0
B)251
C)375
D)400

Question 24

This year T transferred property worth $10,000 (basis $3,000) to C Corporation in exchange for a 15-year bond worth $5,000 and all of C's stock worth $5,000.

A)The transfer is nontaxable because the transferor received stock and debt on the exchange.
B)T must recognize gain of $7,000 since § 351 does not apply to the transaction.
C)T must recognize gain of $5,000.
D)None of the above

Question 25

F and G formed a corporation on March 1 this year.F transferred equipment worth $40,000 (basis $15,000) in exchange for 40 shares of stock, and performed services worth $10,000 in exchange for 10 shares of stock.In exchange for 50 shares of stock, G contributed land worth $70,000 (basis $9,000) subject to a mortgage of $20,000, which the corporation assumed.What is F's total basis in the stock that he received?

A)$15,000
B)$40,000
C)$25,000
D)$50,000
E)None of the above

Question 26

This year C and D formed a new corporation.C and D both contributed appreciated property, receiving 90 and 10 shares of the corporation's stock respectively.

A)C must recognize gain.
B)D must recognize gain.
C)C and D must recognize gain.
D)Neither C nor D must recognize gain.

Question 27

F and G formed a corporation on March 1 this year.F transferred equipment worth $40,000 (basis $15,000) in exchange for 40 shares of stock, and performed services worth $10,000 in exchange for 10 shares of stock.In exchange for 50 shares of stock, G contributed land worth $70,000 (basis $9,000) subject to a mortgage of $20,000, which the corporation assumed.What amount of gross income must F recognize due to the incorporation transaction?

A)$0
B)$10,000
C)$25,000
D)$35,000
E)None of the above

Question 28

F and G formed a corporation on March 1 this year.F transferred equipment worth $40,000 (basis $15,000) in exchange for 40 shares of stock, and performed services worth $10,000 in exchange for 10 shares of stock.In exchange for 50 shares of stock, G contributed land worth $70,000 (basis $9,000) subject to a mortgage of $20,000, which the corporation assumed.What amount of gross income must G recognize due to the incorporation transaction?

A)$0
B)$20,000
C)$11,000
D)$61,000
E)None of the above

Question 29

In a § 351 transfer, stock includes all of the following except

A)Preferred
B)Preferred and nonvoting
C)Nonparticipating
D)Stock rights and warrants

Question 30

During the year, M, N, and O formed a new corporation.Solely in exchange for stock, M and N contributed appreciated property, while O contributed services.The exchanges of M and N will be nontaxable if

A)O receives 30 percent of the stock.
B)O receives 80 percent of the stock.
C)O receives 10 percent of the stock.
D)M and N receive 50 percent of the stock.
E)None of the above

Question 31

During the year, R, S, T, and U formed a new corporation.R contributed appreciated property, S and T contributed cash, and U contributed services.R, S, T, and U each received ¼ of the stock.Based on these facts

A)R must report taxable income.
B)R and U must report taxable income.
C)U must report taxable income.
D)Transfers to a corporation in exchange for stock are nontaxable and thus none of the parties report taxable income.

Question 32

F and G formed a corporation on March 1 this year.F transferred equipment worth $40,000 (basis $15,000) in exchange for 40 shares of stock, and performed services worth $10,000 in exchange for 10 shares of stock.In exchange for 50 shares of stock, G contributed land worth $70,000 (basis $9,000) subject to a mortgage of $20,000, which the corporation assumed.What is G's basis in his stock after the exchange?

A)$0
B)$9,000
C)$20,000
D)$11,000
E)None of the above

Question 33

F and G formed a corporation on March 1 this year.F transferred equipment worth $40,000 (basis $15,000) in exchange for 40 shares of stock, and performed services worth $10,000 in exchange for 10 shares of stock.In exchange for 50 shares of stock, G contributed land worth $70,000 (basis $9,000) subject to a mortgage of $20,000, which the corporation assumed.Due to the exchange, the corporation will report

A)Neither income nor deduction
B)Some amount of income but no amount of deduction
C)No income but some amount of deduction
D)Some amount of income and some amount of deduction

Question 34

J, L, and R formed a new corporation.J exchanged equipment worth $35,000 (basis $8,000) for 35 percent of the stock, and services worth $25,000 for 25 percent of the stock; L exchanged land worth $25,000 (basis $5,000) for 25 percent of the stock; and R received 15 percent of the stock in exchange for securities worth $15,000 (basis $10,000).Which of the following statements is true?

A)The transaction would not be eligible for nonrecognition because more than 20 percent of the stock received was in exchange for services.
B)The transaction will be eligible for nonrecognition, but J will have to recognize gain on the compensation for services.
C)Only the basis of the property transferred is considered in determining whether nonrecognition is granted; the three shareholders owned 80 percent of the property transferred.
D)None of the above

Question 35

This year X, Y, and Z formed a new corporation.X and Y contributed appreciated property for 50 percent of the stock.Z contributed property and services for the remaining 50 percent of the stock.Of the amounts given below, what is the minimum amount of stock that Z must receive for his property contribution if the exchanges of × and Y are to be nontaxable.

A)8 percent
B)10 percent
C)20 percent
D)30 percent
E)50 percent

Question 36

This year D, E, and F formed a new corporation.D exchanged equipment worth $40,000 for 40 percent of the stock and services worth $15,000 for 15 percent of the stock.E exchanged machinery worth $30,000 for 30 percent of the stock and services worth $10,000 for 10 percent of the stock.F exchanged land worth $5,000 for 5 percent of the stock.Which of the following statements is true?

A)F's transfer does not qualify for nonrecognition treatment under § 351 because he did not receive a sufficient equity interest.
B)For § 351 purposes, D, E, and F are treated as owning only 75 percent of the stock and therefore their exchanges of property do not qualify for § 351 treatment.
C)All of the property exchanges qualify for nonrecognition treatment under § 351.
D)More than one of the above is true.
E)None of the above is true.

Question 37

F and G formed a corporation on March 1 this year.F transferred equipment worth $40,000 (basis $15,000) in exchange for 40 shares of stock, and performed services worth $10,000 in exchange for 10 shares of stock.In exchange for 50 shares of stock, G contributed land worth $70,000 (basis $9,000) subject to a mortgage of $20,000, which the corporation assumed.The following statements concern the computation of depreciation of the equipment contributed by F.In which statement is the computation of depreciation correctly described?

A)Assuming F and G were incorporating their partnership, the partnership will report no depreciation and the corporation will report all the depreciation allowable.
B)Assuming F and G had never before been in business, the corporation will compute its depreciation deduction for the entire year by applying the depreciation percentage to the adjusted basis of the property.
C)Assuming F contributed the equipment that she had used in her sole proprietorship business for two years (which is continued by the corporation), the corporation may treat the asset as newly acquired property, use the first year depreciation percentage, and claim 10/12 of the amount so determined in computing depreciation.
D)Assuming F transferred equipment that she had used in her own business, the corporation will merely step into the shoes of F and claim the deduction she would otherwise be able to claim, and
E)None of the above

Question 38

F and G formed a corporation on March 1 this year.F transferred equipment worth $40,000 (basis $15,000) in exchange for 40 shares of stock, and performed services worth $10,000 in exchange for 10 shares of stock.In exchange for 50 shares of stock, G contributed land worth $70,000 (basis $9,000) subject to a mortgage of $20,000, which the corporation assumed.Assuming G recognized $27,500 of gain on the exchange, the corporation's basis for the land received is

A)$9,000
B)$70,000
C)$36,500
D)$50,000

Question 39

F and G formed a corporation on March 1 this year.F transferred equipment worth $40,000 (basis $15,000) in exchange for 40 shares of stock, and performed services worth $10,000 in exchange for 10 shares of stock.In exchange for 50 shares of stock, G contributed land worth $70,000 (basis $9,000) subject to a mortgage of $20,000, which the corporation assumed.If G should sell his stock, the holding period will

A)Include the holding period of the land
B)Begin on the date of the transfer
C)Always be considered long-term regardless of the holding period of the land or the date of the transfer
D)Always be considered short-term regardless of the holding period of the land or the date of the transfer

Question 40

This year D transferred property worth $10,000 (basis $6,000) to a newly formed corporation in exchange for all of its stock worth $10,000.

A)D realizes a $4,000 gain which is not recognized.In addition, D will never pay any tax on this gain.Congress elected to forgive taxes in this instance to ensure that tax considerations do not interfere with the choice of business form.
B)D realizes a $4,000 gain which is not recognized.The gain escapes tax only temporarily.
C)D realizes a $4,000 gain which must be recognized at the time of the exchange.When the shareholder has income, it must be reported.
D)D realizes a gain of $4,000.In this case, the gain must be recognized under the continuity of interest doctrine.

Question 41

Taxable transfers of property to a corporation may be desirable under certain conditions.Taxpayers may avert nonrecognition by

A)Selling the property to the corporation for debt
B)Exchanging the property in a § 351 transaction in which boot is received
C)Exchanging the property with the corporation where § 351 does not apply
D)All of the above

Question 42

During the year, the city of Houston contributed land worth $100,000 to XYZ, Inc.in order to lure the company to establish a factory in the city.XYZ will report

A)$100,000 income and will have a basis in the property of $100,000
B)No income and will have a basis in the property of $100,000
C)No income and will have a zero basis in the property
D)$100,000 income and will have a zero basis in the property

Question 43

This year, A transferred land worth $150,000 (basis $90,000) to his wholly owned corporation in exchange for voting, preferred stock.The land was subject to a mortgage of $40,000.Due to the transfer, A must recognize gain of

A)$0
B)$40,000
C)$60,000
D)$100,000

Question 44

Ten years ago J purchased land for $40,000.The land has appreciated in value and now could be subdivided and sold for $450,000.The land currently constitutes a capital asset for J under § 1221.What form of development of the property would have the most favorable tax consequences for J?

A)Subdivide the property and sell the lots
B)Form a corporation and transfer the property for stock under the nonrecognition provisions of §351
C)Form a corporation to develop the land and sell the land to it, taking an installment note payable for the sales price

Question 45

This year J and K formed New Corporation.J transferred the assets below to New in exchange for stock. $\begin{array} { l }&\text { Adjusted Basis }&\text { Fair Market Value }\\\text { Building }&\$45,000&\$90,000\\\text { Equipment }&100,000&110,000\\\text { Total }&\$145,000&\$200,000\end{array}$
In addition the building was subject to a mortgage of $50,000.J received stock worth $150,000 on the exchange.Assume that the transfer meets the requirements of § 351.J will recognize

A)No gain or loss
B)$5,000 gain
C)$50,000 gain
D)$60,000 gain

Question 46

Which of the following is not directly considered in calculating the basis of stock received in a § 351 transfer?

A)Basis of the property transferred
B)Fair market value of the stock received
C)Fair market value of the property received
D)Liabilities assumed by the corporation

Question 47

N Corporation was formed by L in 2003, issuing $2 million in stock.Several years ago, M was admitted as a new shareholder, receiving 100 shares of stock and a note in exchange for property.The stock and note have a basis of $30,000 and $40,000, respectively.On October 5 of the current year, the corporation declared bankruptcy, and the stock and note became worthless.How much may M deduct on her individual return for this year?

A)$70,000, if married status
B)$50,000, if single status
C)$73,000, if married status
D)$51,500, if single status
E)$3,000, if married or single status

Question 48

This year P and Q formed ABC Corporation.P transferred a building worth $90,000 (basis $25,000) to the corporation in an exchange generally qualifying under § 351.The building was subject to a mortgage of $10,000, and P received stock worth $80,000 on the exchange.P will recognize

A)No gain or loss and have a basis in his stock of $25,000
B)No gain or loss and have a basis in his stock of $15,000
C)A gain of $10,000 and have a basis in his stock of $25,000
D)A gain of $15,000
E)A gain of $65,000

Question 49

B transferred depreciable equipment worth $12,000 (basis $9,000) to his wholly owned corporation this year in exchange for stock worth $7,000 and cash of $5,000.B's gain or loss on the transaction and his basis for the stock received is

A)$3,000 gain, $7,000 basis
B)$0 gain, $9,000 basis
C)$3,000 gain, $12,000 basis
D)$5,000 gain, $9,000 basis
E)None of the above

Question 50

From an individual's perspective, which of the following is not an advantage of utilizing debt when determining whether debt (i.e., long-term securities) or stock should be used as part of the capital structure of the business?

A)It is less costly to pay a return to the investor.
B)It can be transferred without concern for control.
C)It provides a defense against possible imposition of the accumulated earnings tax.
D)It receives more favorable treatment should it become worthless.

Question 51

C incorporated her sole proprietorship two years ago by transferring equipment that was worth $100,000 and had a basis of $40,000 (cost $70,000, depreciation claimed and deducted $30,000).The corporation sold the equipment for $65,000.During the period that the corporation held the asset, it had claimed and deducted $10,000 in depreciation.The corporation must recognize

A)§ 1231 gain of $25,000 and § 1245 gain of $10,000
B)§ 1231 gain of $35,000 only
C)§ 1245 gain of $35,000 only
D)§ 1245 gain of $5,000 only
E)None of the above

Question 52

B, C, and D each own 30 shares of the 90 shares of stock outstanding of We-Cater-To-You Corporation.This year B contributed a van previously used in his proprietorship worth $10,000 (basis $12,000) in exchange for 10 shares of stock.R will

A)Recognize no gain or loss on the exchange and have a basis in the stock received of $10,000
B)Recognize a $2,000 loss on the exchange and have a basis in the stock received of $10,000
C)Recognize no gain or loss on the exchange and have a basis in the stock received of $12,000
D)Recognize a $2,000 loss on the exchange and have a basis in the stock received of $12,000

Question 53

This year, T transferred appreciated property to a newly formed corporation.Which of the following items may not be received if the exchange is to be tax-free?

A)Bonds with a maturity of 15 years
B)Nonvoting cumulative participating preferred stock
C)Neither of the above may be received
D)Both of the above may be received

Question 54

L and R each received $500,000 from their mother to start their own businesses.L transferred her $500,000 to her corporation for shares of stock worth $200,000 and a $300,000 note bearing 10 percent interest.The interest is payable in annual installments of $30,000 for 15 years.In contrast, R contributed his $500,000 to his corporation in exchange solely for stock.Assume both corporations are equally successful and have current EP (earnings and profits) exceeding $30,000 at the end of their first year.During the year, L receives an annual principal payment of $25,000.To acquire $25,000, R redeems stock of his corporation worth $25,000.Which of the following statements is true?

A)L's principal payment is tax-free.
B)L's debt could be reclassified as stock if the corporation were too thinly capitalized.
C)R's $25,000 will be taxed as a dividend.
D)All of the above

Question 55

In January last year, D, single, established a corporation and acquired § 1244 stock.This year the stock, which had a basis of $120,000, became worthless.D had no other property transactions during the year.D's adjusted gross income will decrease because of these transactions by

A)$50,000
B)$120,000
C)$3,000
D)$53,000
E)$103,000

Question 56

This year J and K formed New Corporation.J transferred the assets below to New in exchange for stock. $\begin{array} { l }&\text { Adjusted Basis }&\text { Fair Market Value }\\\text { Building }&\$45,000&\$90,000\\\text { Equipment }&100,000&110,000\\\text { Total }&\$145,000&\$200,000\end{array}$
In addition the building was subject to a mortgage of $50,000.J received stock worth $150,000 on the exchange.Assume that the transfer meets the requirements of § 351.J's basis in his stock is

A)$145,000
B)$95,000
C)$100,000
D)$150,000
E)Some other amount

Question 57

Several years ago, R incorporated his sole proprietorship, receiving stock and debt as part of the transaction.In which of the following situations is the debt likely to be recharacterized as stock?

A)85 percent debt, 15 percent stock
B)50 percent debt, 50 percent stock
C)15 percent debt, 85 percent stock
D)40 percent debt, 60 percent stock

Question 58

Hybrid securities are quite susceptible to being reclassified as stock.Which of the following is characteristic of hybrid securities?

A)A maturity date that is reasonably close in time
B)Interest payable regardless of the corporation's income
C)Not subordinated to debt of general creditors
D)None of the above