Accounting 6073
Fall, 2011

Lesson 3A:  Organization of Corp, Sec 351, Related Problems

I.	Overview
A.	Generally, a corporation recognizes no income on the issuance of stock
	 and shareholder recognizes no income on acquisition of stock.

B.	If purchaser acquires stock for appreciated or depreciated prop, he may have gain or loss (IRC 1001)
1.	Entire realized g/l is generally recognized under IRC 1001c
2.	However, this general Code rule is subject to exceptions

      C.  One of these exceptions is section 351:
		1.  Transferor(s) recognize(s) no gain or loss if
			a. property
			b. transferred to a corporation
			c. solely in exchange for its stock
		d transferor(s) are in control of corporation immediately after the
			 exchange

			2.  A corporation transferring prop to another corporation who is a party to 
			a reorganization recognizes no g/l (IRC 361)
	
D.  Applicability of 351 is critical--w/o it, transferor recognizes gain or loss under 
			general rule (IRC 1001).

	E.  If 351 applies, 
		1.  Basis of stock is same as basis of property given up--(if 351 n/a,
			 basis of stock = its fair market value)
		2.  Rationale:  351 trans doesn't "close" the transferor's investment, but 
			merely changes its form. 

			a.  but (e.g.) corner grocery store-transfer assets to new national
				 grocery chain for .01% interest

		3.  Basis to corp. of acquired prop same as transferor's basis (IRC 362).

II.  	Transfer of Property
	A.  Statute doesn't define "property" 
		1.  Clearly includes money
		2.  Should include shareholder's note--but doesn't create basis in stock for 
			shareholder (so says the Tax Court).
	B.  Stock for Services
		1.  Services rendered to or for benefit of issuing corp.--
			NOT property (351(d)(1) IRC)
		2.  Person receiving stock only for services not counted in
			 determining control group.
3.  If service provider also transfers property of more than nominal value, can be in control group. (10% of value of stock p. 3-10 fn 35).
		4.  e.g. stock transferred 78% for prop, 22% for services--351 will not
			 apply
		5.  If proprietor incorporates and transfers stock to others: look at facts
			 immediately after stock is issued:
			a. If less than 80%, no control unless transfer not integral part
				 of 351 transaction.
b. If proprietor transfers stock to another to satisfy debt of proprietor, proprietor will recognize g/l on transfer of stock  equal to difference b/w amountt of debt and basis of stock.
		6.  Transfer of assets created by transferor's personal efforts 
			a. Basic issue:  transfer of property or stock
				 issued for services?
			b. If property, is there an "exchange" w/in meaning of 351?
			c. Usually transfer of intellectual prop will qualify unless
				 created especially for transferee corp.

	C.  Debt of a corporation as property
		1.  Generally, obligations of a corporation qualify as property if
			 evidenced by security (351(d)(2)IRC)
		2.  If not evidenced by security (e.g. open account)--NOT property
			a. This allows open account creditors to take bad debt
				 deduction even if receive stock

	D.  Accrued Interest 
		1.  Interest on a corp's debt (even if evidenced by security)
			--NOT property (351(d)(3))
		2.  Thus, allocate stock between principal and interest if debt
			 w/accrued interest is transferred.

III. Exchange for Stock--Problems of Classification
	A.  There must be a true exchange (transfer)
		1.  Tension:  Is property transferred, or merely licensed?
			 (especially w/ intellectual property)
		2.  Exchange=exclusive right to use, exploitation and disposition
			 for foreseeable economic life
		3.  IRS would argue--same rules as for recognizing sales of capital assets,
			 but courts don't buy it.

	B.  The term "stock"
		1.  Designed to ensure that transferor will maintain continuing
			 equity interest in transferee corporation
		2.  Stock rights and warrants--NOT considered stock for this
			 purpose
		
	C.  Under prior law, 351 allowed exchange for stock or securities of
		 transferee corp., still applicable in pre 1989 351 transactions.

IV.	Control of the Corporation:  The 80% Rule

A.	In general
1.	351 applies only if transferor(s) in “control” per IRC 368c
2.   Control (Section 368c) means ownership of at least 80% of
		a. Total combined voting power
		b. Total number of shares of all classes of NV stock.

3.	Attribution rules N/A in determining control for this purpose

B.	Voting Stock and Voting Power
1.	Means power to vote for directors
2.	Contingent voting rights not counted unless contingency occurs.

C.	Other classes of stock-must own 80% of shares of EACH class.

V.  Control when 2 or more transferors are involved.

A.	The control “group”
1.  351 applies to such transactions
2.  Each member must 
a. Transfer property
b. Receive only stock (or stock plus boot)
c. Own stock immediately after the exchange

3.	All transfers part of an integrated transaction for 351 to apply

B.	Disproportionate Exchanges

1.	Normally, fmv of stock received =fmv of property given up
2.	If disproportionate, something else is going on
a. Making gifts
b. Paying compensation
c. Satisfying debts or other obligations of transferor

3.	In such case, possible effects on transferor
a. May have gain on disposition of stock
b. May have compensation deduction
4.	Such transactions may have effect on “control” question
	-question is:  was this an integral step in the entire transaction?

VI.	Control immediately after the exchange

A.  Exchange of property for stock doesn’t have to be simultaneous.
      Rather, transaction where rights of the parties are previously defined,
and the agreement proceeds in an orderly manner consistent with those rights probably qualifies.
1.  Thus, multiple transactions, integrated within the overall
	 transaction are considered in determining control
	 “immediately after the exchange”

2.  Step transaction doctrine: control “immediately after” is NOT
	 satisfied if transferors have agreed beforehand to transfer 
	 enough of their stock so that they lose control.  

3.  Test: were the steps so interdependent that legal relations
	 created by one transaction would be fruitless without
	 completion of the series (Manhattan Bldg. Co 27 TC 1032)

4.  If corporate stock transferee was free to transfer or not transfer
	 his /her stock, then “immediately after” test probably satisfied.

	B.  Retransfers for personal reasons (e.g. to spouse, children).
			1.  Courts usually find that 351 applies
				2.  Depends on freedom of transferor

			C.  Corporate retransfer of stock to its subsidiaries doesn’t void 351
				1.  But, may be taxable event for distributor and distributee.

			D.  Multiple drop downs of property to subsidiaries doesn’t void 351

VII. Corporation’s Gain Loss Deduction on Issue or Sale of its Stock

		A.  Generally no gain or loss recognized by corporation receiving money or property
			 for its own stock (IRC 1032).

			1.  Without general rule, corporation would recognize g/l under 1001 IRC.
			2.  Section 1032 rule applies in 351 transactions.
			3.  Section 1032 also applies to corporation buying/selling
				a.  treasury shares 
				b. options in its own stock	
							
		B.  Stock for this purpose is not defined-courts ask “is it really equity?”

		C.  Corporate stock issued for debt discharge doesn’t eliminate COD if stock
			 worth less than face amount of liabilities discharged.

		D.  Non recognition applies only to consideration received in exchange for
			 stock.  Other transactions in tandem taxed in accordance with their true character.
			 (e.g. stock issued as compensation may yield a compensation deduction)

		E.  Corp still recognizes gain (but not loss) if transfers appreciated (depreciated)
			  property as boot.

VIII. Statutory Exclusions from Section 351

		A.  Investment companies-351 N/A to transfer that 
			1.  Diversifies transferor’s interest AND
			2.  Is made to 
				a. Regulated Investment Company.
				b. Real estate investment trust (REIT) 
				c. Corporation whose assets consists mostly (80%) of “investments”

IX. Avoiding Section 351

A.	 Section 351 is mandatory if its terms are satisfied.
B.	However, it’s possible that transferring shareholders may want to avoid 351:
1.	Because they are transferring depreciated property or
2.	Because they want to pay CG tax now (15%) on appreciated property
3.	Because they have CLs that will absorb some or all of the CG.
C.	 When transferring depreciated property, must avoid two code sections:
1.	Section 351—avoid by having control group own < 80%.
2.	Section 267—avoid by having transferor own < 50%.
D.	When transferring appreciated property avoid 351 by :
1.	Selling the property to the corporation for cash (or cash plus debt)
2.	Having the corporation transfer boot to the shareholder in excess of realized 
		gain on transferred property.
3.	 Having the control group own less than 80% of the stock
4.	Transferring the appreciated property subject to liabilities in excess of its basis.

X. Corporate Organizational Expenditures

		A.  Definition: expenses that  
			1.  Are incident to creation of the corporation
			2.  Are chargeable to a capital account
			3.  Would be amortized over life of corporation if it had a limited life
			4.  Examples:  
				a. Legal services related to organizing corporation
				b. Accounting services
				c. Expenses of temporary directors, organizational meetings etc.
			5.  Excluded-stock issuance costs

		B.  Corp may elect to amortize organization costs
			1.  If less than 50K, may elect to expense first $5,000.
			2.  Over 55K, must amortize all.  50-55K, phase out of expensing option
			3.  Balance--amortized over 15 years, starting when corporation begins business.
			4.  Must elect on timely filed return.
			5.  If fail to elect, capitalize and write off on liquidation of corporation

XI. Corporation’s Taxable Year and Method of Accounting

		A.  Taxable year
			1.  Generally corporation may use calendar or fiscal year.
				a. Fiscal year only if keep its books on that basis.
				b. S corps/PSCs may not use fiscal year unless business purpose.

			2.  S corp./PSC may have 9/30, 10/31 or 11/30 year end if 
				a. Makes “required payments” (S corp.) or
				b. Makes “minimum distribution” (PSC).

		B.  Method of accounting-must “clearly reflect income”
			1.  Generally C corporations must use accrual method
			2.  Certain corporations exempt from this rule (if not “tax shelters”)
				a. Certain farming corporations.
				b. Qualified PSCs.
				c. Average annual gross receipts < $5 million.

XII. Corporate Debtor’s Gain on Discharge of Debt at Less than Face Value

		A. In general-
			1.  Retirement of debt at less than face usually is COD income.
			2.  Subject to exceptions in 108 IRC.
			3.  Discharge of contested or contingent liabilities doesn’t create COD. 

		B.  Exceptions to general inclusion rule
			1.  Capital contribution
			2.  If solvent corporation transfers stock to creditor to satisfy obligation, debt
				treated as discharged for stock’s fmv.
			3.  If corp. shareholders take prop subj. to debt in liquidation.
			4.  If insolvent, reduce tax attributes in lieu of COD income.

		C.  Acquisition of debt by “related person” triggers immediate COD income.  It is presumed that they will not enforce the debt against the corporation.

		D.  See examples pp 4-83-4-84.