Question 1

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

Both Gabriella and Maria will have a basis in their shares equal to the value of the property they contributed to the corporation, and since the transfer did not result in gain, they will not recognize any gain on the transfer.

Question 2

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

§ 351 allows tax-free transfers of property to a corporation, and it can be used for later transfers such as contributions or exchanges with existing shareholders.

Question 3

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

Accepted Answer

Both § 1031 like-kind exchange provision and § 351 allow taxpayers to defer recognition of gain or loss when certain conditions are met. This deferral is justified under the wherewithal to pay concept, which recognizes that taxpayers may not have sufficient cash on hand to pay the tax liability resulting from the recognition of gain or loss. By deferring the recognition of gain or loss, taxpayers are able to continue to invest their money and generate income, which in turn generates the cash needed to pay their tax liability in the future.

Question 4

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

The statement is correct. Section 351 of the Internal Revenue Code allows for the tax-deferred exchange of property for stock in a corporation. However, this tax treatment is only available if property is transferred, not if cash or services are exchanged for stock. Therefore, the definition of "property" is important to determine eligibility for § 351 treatment.

Question 5

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

Accepted Answer

According to the IRS, if a transferor receives consideration other than stock (such as cash or property), the transaction is not tax-free and may be taxable. Only when the transferor receives only stock in exchange for the transfer of property, the transaction is tax-free under § 351 of the Internal Revenue Code.

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

This is the correct definition of the control requirement under § 351 of the Internal Revenue Code.

Question 7

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

Accepted Answer

In a transaction subject to § 351, a taxpayer may only defer recognition of a loss, but they can never recognize a loss. This is because § 351 allows for the transfer of property to a corporation in exchange for stock, and any loss on the transfer is treated as a reduction in the basis of the stock received.

Question 8

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

Services are not considered property for the purposes of § 351, so stock received for services must be treated as income and reported at its fair market value.

Question 9

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 has recognized a capital gain of $40,000 on the transfer since the fair market value of the securities ($300,000) exceeds their adjusted basis ($120,000) by $180,000. However, it is not specified whether this is a long-term or short-term capital gain, as that would depend on how long Allen held the securities before transferring them.

Question 10

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 half the shares to Ted could trigger a taxable event under the rules of Section 351 of the IRS code. If the transfer does not meet certain requirements or if Sofia and Ted have an agreement to sell the appreciated property for a profit, the initial transfer could be taxable.

Question 11

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

According to Section 351 of the Internal Revenue Code, the transfer of appreciated property to a controlled corporation in exchange for stock does not result in recognition of gain to the transferor if certain requirements are met. However, if the stock received is nonqualified preferred stock, gain must be recognized to the extent of the fair market value of the stock received.

Question 12

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 13

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.

Question 14

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

The answer of In order to retain the services of...

Question 15

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 16

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

Accepted Answer

The answer of For § 351 purposes, stock rights and...

Question 17

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

Accepted Answer

If a transaction qualifies under § 351, any recognized gain is not equal to the value of the boot received. Rather, any recognized gain is calculated by subtracting the adjusted basis of the property transferred from the fair market value of the property received, minus any boot received.

Question 18

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

The transfer of an installment obligation in a transaction qualifying under § 351 generally does not trigger a gain or a loss for the transferor, as long as certain requirements are met. This is because the transfer is treated as a contribution to the capital of the transferee corporation, and the transferor holds an equity interest in the corporation in exchange. However, if the transferor receives boot (other consideration besides stock) in the exchange, gain or loss may be recognized on the portion of the installment obligation deemed to be satisfied by the boot.

Question 19

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 20

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.

Quiz 18: Corporations: Organization and Capital Structure