Question 1

In structuring the capitalization of a corporation, the tax law is neutral for the investor as to debt versus equity financing.

Accepted Answer

The tax law is not neutral for the investor as to debt versus equity financing. Interest paid on debt is deductible for tax purposes, while dividends paid on equity are not. This can make debt financing more attractive to investors in terms of tax savings.

Question 2

A shareholder transfers a capital asset to Red Corporation for its stock. If the transfer qualifies under § 351, Red's holding period for the asset begins on the day of the exchange.

Accepted Answer

Red Corporation's holding period for the capital asset includes the shareholder's holding period, provided the asset was a capital asset or a Section 1231 asset in the hands of the transferor.

Question 3

When incorporating her sole proprietorship, Samantha transfers all of its assets and liabilities. Included in the $30,000 of liabilities assumed by the corporation is $500 that relates to a personal expenditure. Under these circumstances, the entire $30,000 will be treated as boot.

Accepted Answer

The answer of When incorporating her sole proprietorship, Samantha transfers...

Question 4

Carl and Ben form Eagle Corporation. Carl transfers cash of $50,000 for 50 shares of stock of Eagle. Ben transfers proprietary information with a tax basis of zero and a fair market value of $50,000 for the remaining 50 shares in Eagle. Carl will have a tax basis of $50,000 in his stock in Eagle Corporation and Ben's basis in his stock will be zero.

Accepted Answer

This is known as a contribution of property in exchange for stock, and the basis in the stock received is equal to the fair market value of the property transferred. Carl's basis in his stock is $50,000, which is the value of the cash he transferred, and Ben's basis in his stock is also $50,000, which is the fair market value of the proprietary information he transferred in exchange for the stock.

Question 5

If both §§ 357b) and c) apply to the same transfer i.e., the liability is not supported by a bona fide business purpose and also exceeds the basis of the properties transferred), § 357c) predominates.

Accepted Answer

The answer of If both §§ 357b) and c) apply...

Question 6

A city contributes $500,000 to a corporation as an inducement to locate in the city. Within the next 12 months, the corporation uses the money to purchase property worth $500,000. The corporation has income of $500,000 and must reduce its tax basis in the property by the same amount.

Accepted Answer

The $500,000 received by the corporation is not considered income but rather a capital contribution from the city to induce the corporation to locate there. Therefore, it does not increase the corporation's income, nor does it require a reduction in the tax basis of the property purchased with those funds.

Question 7

To encourage the development of an industrial park, a county donates land to Ecru Corporation. The donation results in gross income to Ecru.

Accepted Answer

The donation of land to Ecru Corporation is considered a form of income, which results in gross income for the corporation.

Question 8

To help avoid the thin capitalization problem, it is advisable to make the repayment of the debt contingent upon the corporation's earnings.

Accepted Answer

The answer of To help avoid the thin capitalization problem,...

Question 9

A taxpayer transfers assets and liabilities to a corporation in return for its stock. If the liabilities exceed the basis of the assets transferred, the taxpayer will have a negative basis in the stock.

Accepted Answer

When a taxpayer transfers assets and liabilities to a corporation in return for its stock, if the liabilities exceed the assets' basis, the excess is treated as gain to the taxpayer; it does not result in a negative basis in the stock received.

Question 10

To ease a liquidity problem, all of the shareholders of Osprey Corporation contribute additional cash to its capital. Osprey has no tax consequences from the contribution.

Accepted Answer

Shareholder contributions to capital do not have tax consequences for the corporation.

Question 11

Kim, a real estate dealer, and others form Eagle Corporation under § 351. Kim contributes inventory land held for resale) in return for Eagle stock. The holding period for the stock includes the holding period of the inventory.

Accepted Answer

Under § 351, when 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 of the corporation, the exchange is generally tax-free. However, the holding period of the stock received does not include the holding period of the inventory (land held for resale) contributed. The holding period for the stock begins on the date of the exchange.

Question 12

When a taxpayer transfers property subject to a mortgage to a controlled corporation in an exchange qualifying under § 351, the transferor shareholder's basis in stock received in the transferee corporation is increased by the amount of the mortgage on the property.

Accepted Answer

In a § 351 exchange, the transferor's basis in the stock received is decreased (not increased) by the amount of the liability (such as a mortgage) assumed by the corporation.

Question 13

A shareholder contributes land to his wholly owned corporation but receives no stock in return. The corporation has a zero basis in the land.

Accepted Answer

When a shareholder contributes property (such as land) to a corporation in exchange for stock, the corporation's basis in the property is generally the same as the shareholder's adjusted basis, just before the contribution. This rule applies even if the shareholder owns 100% of the corporation.

Question 14

When depreciable property is transferred to a controlled corporation under § 351, any recapture potential disappears and does not carry over to the corporation.

Accepted Answer

When depreciable property is transferred to a controlled corporation under § 351, any recapture potential (such as depreciation recapture under sections 1245 or 1250 of the Internal Revenue Code) carries over to the corporation. The corporation assumes the transferor's potential recapture liability.

Question 15

In general, the basis of property to a corporation in a transfer that qualifies as a nontaxable exchange under § 351 is the basis in the hands of the transferor shareholder decreased by the amount of any gain recognized on the transfer.

Accepted Answer

In a transfer that qualifies as a nontaxable exchange under § 351, the basis of the property to the corporation is generally the same as the basis in the hands of the transferor shareholder, increased by any gain recognized by the shareholder on the transfer.

Question 16

A shareholder's holding period for stock received under § 351 can include the holding period of the property transferred to the corporation.

Accepted Answer

The holding period of the stock received under § 351 is determined by adding the holding period of the property transferred to the corporation. This allows for preferential long-term capital gains treatment if the property being transferred had been held for more than one year.

Question 17

Because boot is generated under § 357b) i.e., the liability is not supported by a bona fide business purpose), the transferor shareholder will always have to recognize gain.

Accepted Answer

The recognition of gain due to boot in a transaction under § 357(b) depends on whether the liabilities exceed the basis of the assets transferred. If the liabilities assumed by the corporation exceed the transferor's basis in the assets transferred, then gain is recognized to the extent of the excess, not solely because the liability lacks a bona fide business purpose.

Question 18

Basis of appreciated property transferred minus boot received including liabilities transferred) plus gain recognized
equals basis of stock received in a § 351 transfer.

Accepted Answer

This formula is correct and is used to calculate the basis of stock received in a § 351 transfer.

Question 19

In determining whether § 357c) applies, assess whether the liabilities involved exceed the bases of all assets a shareholder transfers to the corporation.

Accepted Answer

§ 357c) applies when the liabilities involved with the transfer of assets to a corporation exceed the bases of all assets a shareholder transfers to the corporation.

Question 20

In return for legal services worth $60,000 rendered incident to its formation, Crimson Corporation issues stock to Greta, an attorney. Crimson cannot immediately deduct the value of any of this stock but instead must capitalize it as an organizational expenditure.

Accepted Answer

This is correct because organizational expenses, such as legal fees incurred during the formation of a corporation, cannot be immediately deducted as an expense but rather must be capitalized and amortized over a period of time.

Quiz 4: Corporations: Organization and Capital Structure