Question 1

The receipt of nonqualified preferred stock in exchange for the transfer of appreciated property to a controlled corporation results in recognition of gain to the transferor.

Accepted Answer

The receipt of nonqualified preferred stock in exchange for the transfer of appreciated property to a controlled corporation is treated as "other property or money" under Section 351 of the Internal Revenue Code, which results in the recognition of gain to the extent of the lesser of the fair market value of the nonqualified preferred stock received or the realized gain on the transfer.

Question 2

In a § 351 transfer, a shareholder receives boot of $10,000 but ends up with a realized loss of $3,000. Only $7,000 of the boot will be taxed to the shareholder.

Accepted Answer

In a § 351 transfer, if a shareholder receives boot and realizes a loss, the loss is not recognized, and the entire amount of the boot ($10,000 in this case) is taxed to the shareholder.

Question 3

In order to retain the services of Eve, a key employee in Ted's sole proprietorship, Ted contracts with Eve to make her a 30% owner. Ted incorporates the business, receiving in return 100% of the stock. Three days later, Ted transfers 30% of the stock to Eve. Under these circumstances, § 351 will apply to the incorporation of Ted's business.

Accepted Answer

False

Question 4

For § 351 purposes, stock rights and stock warrants are included in the definition of "stock."

Accepted Answer

Stock rights and stock warrants are generally not considered "stock" for the purposes of § 351, which pertains to the non-recognition of gain or loss on the transfer of property to a corporation in exchange for stock.

Question 5

Allen transfers marketable securities with an adjusted basis of $120,000, fair market value of $300,000, for 85% of the stock of Heron Corporation. In addition, he receives cash of $40,000. Allen recognizes a capital gain of $40,000 on the transfer.

Accepted Answer

Allen receives cash in addition to stock, which is considered "boot" in a tax-free exchange. The gain recognized is the lesser of the realized gain or the boot received, which in this case is $40,000.

Question 6

The control requirement under § 351 requires that the person or persons transferring property to the corporation immediately after the transfer own stock possessing at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation.

Accepted Answer

Section 351 of the Internal Revenue Code requires that for a transfer of property to a corporation to be tax-free, the transferor(s) must control the corporation immediately after the transaction, with "control" defined as owning at least 80% of both the total combined voting power of all voting stock and at least 80% of the total shares of each other class of nonvoting stock.

Question 7

The use of § 351 is not limited to the initial formation of a corporation, and it can apply to later transfers as well.

Accepted Answer

Section 351 of the Internal Revenue Code applies not only to the initial formation of a corporation but also to subsequent transfers of property to a corporation by shareholders in exchange for stock, as long as the transferors control the corporation immediately after the exchange.

Question 8

Gabriella and Maria form Luster Corporation with each receiving 50 shares of its stock. Gabriella transfers cash of
$50,000, while Maria transfers a proprietary formula (basis of $0; fair market value of $50,000). Neither Gabriella nor Maria will recognize gain on the transfer.

Accepted Answer

Under Section 351 of the Internal Revenue Code, no gain or loss is recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation, and immediately after the exchange, such person or persons are in control (meaning ownership of at least 80% of both the stock and voting power) of the corporation. In this scenario, since Gabriella and Maria are exchanging property (cash and a proprietary formula) for stock and together they control the corporation immediately after the exchange, neither would recognize gain on the transfer.

Question 9

When consideration is transferred to a corporation in return for stock, the definition of "property" is important because tax deferral treatment of § 351 is available only to taxpayers who transfer property.

Accepted Answer

Under § 351 of the Internal Revenue Code, the term "property" is crucial because the section allows for the deferral of recognition of gain or loss when property is transferred to a corporation in exchange for its stock, provided certain conditions are met. Cash, tangible assets, and intangible assets can all be considered property for the purposes of this section.

Question 10

The transfer of an installment obligation in a transaction qualifying under § 351 is a disposition of the obligation that causes gain to be recognized by the transferor.

Accepted Answer

Under § 351 of the Internal Revenue Code, the transfer of property to a corporation by one or more persons solely in exchange for stock in such corporation, and immediately after the exchange such person or persons are in control of the corporation, does not require the recognition of gain or loss by the transferor. This includes the transfer of installment obligations, which does not result in immediate gain recognition at the time of the transfer.

Question 11

Tina incorporates her sole proprietorship with assets having a fair market value of $100,000 and an adjusted basis of
$110,000. Even though § 351 applies, Tina may recognize her realized loss of $10,000.

Accepted Answer

Under § 351 of the Internal Revenue Code, no gain or loss is recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation, and immediately after the exchange, such person or persons are in control (meaning ownership of at least 80% of both the stock and voting power) of the corporation. The rule applies regardless of whether the property transferred has appreciated or depreciated in value, meaning Tina cannot recognize her realized loss of $10,000 upon transferring her sole proprietorship assets to the corporation.

Question 12

A taxpayer may never recognize a loss on the transfer of property in a transaction subject to § 351.

Accepted Answer

A taxpayer may never recognize a loss on the transfer of property in a transaction subject to § 351 because the transaction is considered a non-taxable exchange.

Question 13

Because services are not considered property under § 351, a taxpayer must report as income the fair market value of stock received for such services.

Accepted Answer

Under § 351 of the Internal Revenue Code, the transfer of property to a corporation in exchange for its stock is generally not a taxable event if the transferor(s) control the corporation immediately after the exchange. However, services are not considered "property" under this section, so if a taxpayer receives stock in exchange for services rendered to the corporation, the fair market value of the stock is considered compensation for the services and must be reported as income.

Question 14

Ruth transfers property worth $200,000 (basis of $60,000) to Goldfinch Corporation. In return, she receives 80% of its stock (worth $180,000) and a long-term note executed by Goldfinch and made payable to Ruth (worth $20,000). Ruth will recognize no gain on the transfer.

Accepted Answer

Ruth will recognize gain to the extent of the lesser of the gain realized or the fair market value of the "boot" received, which in this case is the long-term note worth $20,000. The gain realized is the difference between the fair market value of the property transferred ($200,000) and its basis ($60,000), which is $140,000. Since she received a note worth $20,000, she must recognize $20,000 as gain.

Question 15

A person who performs services for a corporation in exchange for stock cannot be treated as a member of the transferring group even if that person also transfers some property to the corporation.

Accepted Answer

A person who performs services for a corporation in exchange for stock can be treated as a member of the transferring group if that person also transfers property to the corporation, as long as the property transfer is significant in relation to the service provided.

Question 16

In a § 351 transaction, if a transferor receives consideration other than stock, the transaction can be taxable.

Accepted Answer

In a § 351 transaction, if a transferor receives "boot" (consideration other than stock, such as cash or property), the transaction can be partially taxable to the extent of the boot received.

Question 17

Sofia forms Lark Corporation with a transfer of appreciated property in exchange for all of its shares. Shortly thereafter, she transfers half her shares to her son, Ted. The later transfer to Ted could cause the original transfer to be taxable.

Accepted Answer

The transfer of shares to Ted could be seen as part of a prearranged plan to give Ted an interest in the property, potentially disqualifying Sofia from the nonrecognition of gain treatment typically available for transfers of property to a corporation in exchange for its stock under Section 351 of the Internal Revenue Code.

Question 18

If a transaction qualifies under § 351, any recognized gain is equal to the value of the boot received.

Accepted Answer

The answer of If a transaction qualifies under § 351,...

Question 19

Similar to the like-kind exchange provision, § 351 can be partly justified under the wherewithal to pay concept.

Accepted Answer

Section 351, which allows for the tax-free transfer of property to a corporation by one or more persons in exchange for stock, can be partly justified under the wherewithal to pay concept because the transferors do not receive cash or other liquid assets in the exchange, and thus may not have the immediate financial ability to pay tax on any gain realized.

Question 20

Similar to like-kind exchanges, the receipt of "boot" under § 351 can cause loss to be recognized.

Accepted Answer

Under § 351, the receipt of "boot" (additional consideration) does not cause loss to be recognized; it can, however, trigger the recognition of gain if the amount of boot received exceeds the basis of the property transferred. Losses are generally not recognized in § 351 transactions.

Quiz 18: Corporations: Organization and Capital Structure