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.

Accepted Answer

L's corporation can claim a $50,000 deductible expense on its tax return for the interest payment, whereas R's corporation cannot deduct the dividend payment. L will report the interest income on his individual return, while R will report the dividend income.

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.

Accepted Answer

For stock to qualify as § 1244 stock, the corporation's total capital must not exceed $1 million at the time of the stock issuance. Since the new corporation's total capital was $500,000, it meets this requirement, but the qualification for § 1244 stock depends on other factors as well, not just the transfer amount or capital size alone.

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.

Accepted Answer

As per the rules of Section 351 of the Internal Revenue Code, B can transfer property to the corporation in exchange for additional shares without recognizing any gain or loss. Therefore, B is not required to recognize gain on the transfer of land worth $20,000 (basis $11,000) to the corporation for additional shares, increasing his ownership to 88 percent.

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.

Accepted Answer

According to IRS regulations, when stock is received in an exchange qualifying for nontaxable treatment under § 351, the holding period of the stock begins on the date the transferred asset was acquired, assuming the asset was a building used in the transferor's sole proprietorship. This is stated in Treasury Regulations 1.1223-3(d).

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.

Accepted Answer

For stock to qualify as § 1244 stock, among other requirements, the total capital contributed to the corporation (including both money and property) must not exceed $1 million at the time the stock is issued. Since the corporation's total contributed capital was $5 million, the stock does not qualify 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.

Accepted Answer

Section 1244 stock designation applies to the original holder of the stock who received it in exchange for money or other property (not including stock and securities). It does not transfer to subsequent buyers, so the stock would not qualify as § 1244 stock in the 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.

Accepted Answer

The individual providing accounting services is receiving compensation in the form of stock, which is a taxable event and must be recognized as income. The corporation may be able to deduct or capitalize the expenditure depending on the circumstances.

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.

Accepted Answer

If the court recharacterizes a corporation's debt obligations as stock, it means that the individual holding the debt may now be considered a shareholder instead of a creditor. This can lead to unfavorable tax consequences as the individual may now be subject to taxes on the dividends received from the stock instead of being able to claim interest deductions on the 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.

Accepted Answer

K must recognize a gain on the transfer because the transfer of property to a corporation in exchange for its stock is generally a taxable event unless the transferors are in control of the corporation immediately after the exchange, defined as owning at least 80% of the corporation. Here, even with J's additional cash contribution, K and J together do not reach the 80% control threshold after the transaction, as K only receives 50 shares out of a total 200 shares, equating to 25% control for K and 75% for J combined, which does not meet the 80% requirement.

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.

Accepted Answer

The fact that Manager's stock qualifies as § 1244 stock is irrelevant to the question of whether the transferor's cash contribution qualifies for any tax benefits.

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.

Accepted Answer

J must recognize gain to the extent of the lesser of the gain realized or the boot received. The gain realized is $30,000 ($50,000 fair market value - $20,000 basis). However, since the only "boot" received is the relief of debt ($15,000), and it is less than the realized gain, J must recognize gain of $15,000. This is consistent with the general rule, but the explanation provided in the question implies the gain is due to other reasons, not the specific rule regarding relief of debt as boot.

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.

Accepted Answer

If the investments become worthless after three years, the individual would benefit from receiving the § 1244 stock as it qualifies for ordinary loss treatment under the tax code, allowing for a deduction of up to $50,000 of ordinary income per year for single filers and $100,000 for married couples filing jointly. The $20,000 note would not qualify for this tax benefit.

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.

Accepted Answer

According to the section 351 of the Internal Revenue Code, when property is transferred to a corporation in exchange for its stock, the transferor's basis in the stocks received is the same as the corporation's basis in the transferred property. Thus, N's basis in the stock received is $25,000, which is the corporation's basis for the property transferred.

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.

Accepted Answer

R does not have to recognize income because the transfer of property (land) for stock is generally non-taxable if the transferors are in control of the corporation immediately after the exchange. However, S must recognize income for the services rendered in exchange for stock, as the transfer of services for stock is considered taxable compensation.

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.

Accepted Answer

The value of the property transferred to the corporation ($70,000) minus the mortgage on the property ($10,000) equals the value of the stock that P received ($60,000). Since P's basis in the property was $30,000, her basis in the stock is $30,000 (the value of the property minus the mortgage) plus any additional consideration paid for the stock, which is $0 in this case. Therefore, her basis in the stock is $30,000, not $20,000, as stated in the question.

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.

Accepted Answer

This is considered a transfer to a related party, which is generally not taxable as long as the transferor retains control of the corporation immediately after the exchange. In this case, M did retain control briefly after transferring 30% of the stock to her sister, so there is no taxable event.

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.

Accepted Answer

Nonshareholder contributions received by a corporation as an inducement to operate in a particular location are not included in gross income; they are treated as capital contributions.

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.

Accepted Answer

G must recognize gain on the transfer because the transaction involves a sale of property to the corporation in exchange for a note, which is considered a taxable event. The gain recognized would be the difference between the land's fair market value ($20,000) and its basis ($11,000).

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.

Accepted Answer

Under § 351, while the transfer of property to a corporation in exchange for its stock can allow for nonrecognition of gain or loss, the assumption of liabilities by the corporation can trigger gain recognition to the extent that the liabilities assumed exceed the basis of the assets transferred. The liability is not ignored; it is considered in determining the gain recognized by the proprietor.

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.

Accepted Answer

Section 1244 stock retains its status only in the hands of the original holder who acquired it directly from the corporation in exchange for money or property.

Quiz 2: Corporate Formation and Capital Structure