21
1 3. Corporations— Organization & Capital Structure L. Bravenec (rights reserved) 10 July 2001

3. Corporations- Organization & Capital Structure

Embed Size (px)

Citation preview

Page 1: 3. Corporations- Organization & Capital Structure

1

3. Corporations—Organization & Capital Structure

L. Bravenec

(rights reserved)

10 July 2001

Page 2: 3. Corporations- Organization & Capital Structure

2

3.1. Organization: S/H’s Acquiring or Increasing an Interest

• Transfers of Property to a Corporation in Exchange for its Stock and/or other property

• This is a Taxable Event, so . . . .

Page 3: 3. Corporations- Organization & Capital Structure

3

3.1: Organization S/H’s Acquiring or Increasing an Interest

• The Context--Property Transactions– Step 1. Taxable event

– Step 2. Gain/loss realized (Asset by asset)

– Step 3A. Gain/loss recognized (Asset by asset) 3B. Exchanged basis in replacement

property

– Step 4. Gain/loss character (Asset by asset)

– Step 5. Gain exclusions/inclusions and loss disallowances/allowances

Page 4: 3. Corporations- Organization & Capital Structure

4

Full Recognition of G/L

(w/o special S/H nonrecognition provision)

• Ex. 1• S/H contributes properties X, Y, and Z to Newco Corp. in

exchange for $300 stock and $200 debt. [W/O nonrecognition]

Prop. Prop. Step 2 Step 3A Property Basis FMV G/Lreal G/L recog.

– X 100 200 100 100

– Y 150 200 50 50

– Z 150 100 (50) (50) Basis: $300 in stock and $200 in debt

• Corp.: 0 gain [Step 5]. Also, basis is 200 + 200 + 100.

Page 5: 3. Corporations- Organization & Capital Structure

5

Under the S/H Non Recognition Provision

• S/H– 3A. Non recognition of all/part of G/L

• Loss is not recognized on any property transferred

• Gain recognized on a property is the lesser of gain realized or “boot” applicable to the property

– 3B. Basis of stock is “exchanged basis” New basis = old basis + gain recognized - boot received

• Corp.--excluded gain [Step 5]; transferred basis

Page 6: 3. Corporations- Organization & Capital Structure

6

Under the Non Recognition Provision

• S/H– Ex. 2 [Facts same as Slide 5, but nonrecognition provision applies]

– 3A. Non recognition of all/part G/L• Prop. Basis FMV G/Lreal Boot G/Lrec.

X 100 200 100 80 80 Y 150 200 50 80

50 Z 150 100 (50) _40 __0

• Total 400 200 130– 3B. Basis of stock is “exchanged basis”

• 400 + 130 - 200 = 330

Page 7: 3. Corporations- Organization & Capital Structure

7

Under the Non Recognition Provision

• Corp. [Ex. 2]

– No G/L on issuance of its own stock [Step 5]

– Transferred basis in property• Property basis = S/H’s basis + S/H’s gain recognized

• Unclear--how to apportion the increase from a S/H’s gain among assets transferred to the corp.

• Prop. X $100 + $80 = $180

• Prop. Y $150 + $50 = $200

• Prop. Z $150 + $ 0 = $150

Page 8: 3. Corporations- Organization & Capital Structure

8

Shareholder Non Recognition--

Requirements

• Transfer of Property to the corporation– by one or more persons

• In exchange for Stock – Or in exchange for stock and “boot”

• Resulting in 80% Control immediately after the transfer– by the persons who transfer property

Page 9: 3. Corporations- Organization & Capital Structure

9

Liabilities Burdening Transferred Property or Assumed by the Corporation

• Should liabilities be considered as “boot” – in Step 2 (amount realized)?– in Step 3A (recognition of gain)? – in Step 3B (basis of stock)?

Page 10: 3. Corporations- Organization & Capital Structure

10

Liabilities Burdening Transferred Property or Assumed by the Corporation

• Should liabilities be considered as “boot” • in Step 2 (amount realized)--yes

• in Step 3A (recognition of gain)

– No, generally– Exception #1, yes if “bad” motive in incurring any liability

Exception #2, liabilities* in excess of basis

• in Step 3B [basis of stock = basis of property + gain recognized - “boot”]--yes*– [*Do not count as “boot” liabilities which give rise to a deduction when

paid, accounts payable of cash method taxpayer and liabilities of accrual method taxpayer with no economic performance.]

Page 11: 3. Corporations- Organization & Capital Structure

11

Liabilities

• Ex. 3. S/H transfers to corporation in a 351 transaction land worth $300 and subject to a $200 mortgage, when his/her basis is alternatively $250/$150, in exchange for stock worth $100. $250 $150– Step 2, gain realized of $ 50 $150– Step 3A: gain recognized of $ 0 $ 50– Step 3B: stock basis of $ 50 $ 0

Page 12: 3. Corporations- Organization & Capital Structure

12

Choices

• Alternatives for making property available to the corporation:– 1. Transfer in exchange for stock (351)– 2. Recognition of gain (avoiding 351)– 3. Transfer facilitating later withdrawal

– Loan of funds

– Lease of tangible assets

– License of intangible assets

Page 13: 3. Corporations- Organization & Capital Structure

13

Avoidance of Non Recognition

• Would the parties ever want to avoid the non recognition provision? Perhaps– Possible double income

– Appreciated property to be transferred to the corp. is likely to be sold soon, &/or is a 1221/1231 asset to the S/H but will be “ordinary” to the corporation

• Ex. 4: B will transfer farm land with a basis of $200. (i) B can sell it to a 3rd person for $500 as it is. (ii) Or B can develop it for an additional cost of $300 and sell the lots for $1,000. (iii) Or B can sell it to his/her corporation for $500; the corporation would develop it for an additional cost of $300 and sell the lots for $1,000.

Page 14: 3. Corporations- Organization & Capital Structure

14

Avoidance of Non Recognition

• 1. Avoid 80% control, i.e., bust 351.

• 2. Separate sale to the corp. or a subsidiary of the corp.,

• [e.g., for cash, corporation debt, &/or non qualified preferred stock.]

• 3. “Boot” • [e.g., cash, corporation debt, &/or non qualified preferred stock.]

• 4. Liabilities burdening property or assumed by the corporation--either bad motive, or excess liabilities.

Page 15: 3. Corporations- Organization & Capital Structure

15

Transfers Facilitating Later Withdrawal

• Some possibilities• Money• Equipment• Real estate• Intangible

• Factors• Will the S/H need the property?• Will the S/H want to withdraw the property from the

corporation?

Page 16: 3. Corporations- Organization & Capital Structure

16

3.2 Capital Structure

• Common stock

• Preferred stock

• Debt (accounts and notes receivable)

• Leases & licenses

Page 17: 3. Corporations- Organization & Capital Structure

17

Stock

• Losses– CL, unless 1244 (“small business stock”)

• Gains– 50% deduction, 28% rate for 1202 (“qualified

small business stock”)

• The Subchapter S election• No preferred stock outstanding

Page 18: 3. Corporations- Organization & Capital Structure

18

Debt

• Is debt in substance equity? “Cliff” treatment.• Factors

• Debt: equity ratio. 3:1 v. 9:1

• Essential assets

• Subordination

• Convertible into stock

• Payment of interest/principal contingent on profits

• Formalities

• Interest and principal paid when due?

Page 19: 3. Corporations- Organization & Capital Structure

19

Debt

• Is debt in substance equity? “Cliff” treatment.• Factors

• Debt: equity ratio. 3:1 v. 9:1

• Essential assets

• Subordination

• Convertible into stock

• Payment of interest/principal contingent on profits

• Formalities

• Interest and principal paid when due?

Page 20: 3. Corporations- Organization & Capital Structure

20

Debt

• Losses on debt– Holding for business reasons

– Ordinary loss– E.g., an employee-S/H lends money to the corporation

principally to protect his/her job.

– Holding for investment or personal reasons– Corp. S/H owning 80% of operating subsidiary debtor—

ordinary loss– Other creditor--capital loss

» “Securities”: probable LTCL» Other: STCL automatically

Page 21: 3. Corporations- Organization & Capital Structure

21

Leases and Licenses

• “Cliff” treatment not applicable.