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Exam 18: Corporations: Organization and Capital Structure

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Question 21

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

A) True
B) False

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Question 22

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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.

A) True
B) False

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Question 23

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Lark City donates land worth $300,000 and cash of $100,000 to Orange Corporation as an inducement to locate in the city. Four months later, Orange purchases additional land and a building at a cost of $500,000 and moves its operations to Lark City. Ann, the sole shareholder, contributes equipment (basis of $70,000 and fair market value of $200,000) to help Orange in its new operations. What are the tax consequences of these transfers to Orange Corporation?

When Pheasant Corporation was formed under § 351, Kristen transferred property (basis of $26,000 and fair market value of $22,500) for § 1244 stock. Kristen's basis in the Pheasant stock is $26,000. Three years later, Pheasant Corporation goes bankrupt and its stock becomes worthless. Kristen, who is single, owned the stock as an investment. Kristen's loss is:

Wren Corporation (a minority shareholder in Lark Corporation) has made loans to Lark Corporation that become worthless in the current year.

Rhonda and Marta form Blue Corporation. Rhonda transfers land (basis of $55,000 and fair market value of $180,000) for 50 shares plus $20,000 cash. Marta transfers $160,000 cash for 50 shares in Blue Corporation.

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.

Dawn, a sole proprietor, was engaged in a service business and reported her income on a cash basis. Later, she incorporates her business and transfers the assets of the business to the corporation in return for all the stock in the corporation plus the corporation's assumption of the liabilities of her proprietorship. All the receivables and the unpaid trade payables are transferred to the newly formed corporation. The assets of the proprietorship had a basis of $105,000 and fair market value of $300,000. The trade accounts payable totaled $25,000. There was a note payable to the bank in the amount of $95,000 that the corporation assumes. The note was issued for the purchase of computers and other business equipment.

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.

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.

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 not apply to the incorporation of Ted's business.

Rachel owns 100% of the stock of Cardinal Corporation. In the current year Rachel transfers an installment obligation, tax basis of $180,000 and fair market value of $350,000, for additional stock in Cardinal worth $350,000.

Jane transfers property (basis of $180,000 and fair market value of $500,000) to Green Corporation for 80% of its stock (worth $425,000) and a long-term note (worth $75,000) , executed by Green Corporation and made payable to Jane. As a result of the transfer:

Stock in Merlin Corporation is held equally by Jane, Eve, and Fred. Merlin seeks additional capital to buy a valuable tract of land that will cost $6,000,000. Jane, Eve, and Fred propose to loan Merlin $2,000,000 each, taking from Merlin a $2,000,000 ten-year note with interest payable annually at five points above the prime rate. Merlin Corporation has current taxable income of $7,000,000. How are the payments on the notes treated for tax purposes?

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.

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

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.

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

Ann transferred land worth $200,000, with a tax basis of $40,000, to Brown Corporation, an existing entity, for 100 shares of its stock. Brown Corporation has two other shareholders, Bill and Bob, each of whom holds 100 shares. With respect to the transfer:

For transfers falling under § 351, what are the holding period rules for stock received by the shareholder and for the assets transferred to the corporation?