Transcript IRC 351 - College of Business

Tax 4022/5022
Federal Income Tax II
Chapter 18
Dr. Robert R. Oliva
Ph.D., LL.M., J.D., CPA
Professor and Chairperson
Department of Accounting
University of Arkansas at Little Rock
Robert R. Oliva, Professor
IRC 351: Transfers to Controlled
Corporations
INTRODUCTION
• CREATION OF A CORPORATION BY
TRANSFERRING DEPRECIATED
PROPERTY MAY TRIGGER REALIZED
GAIN.
• REALIZED GAIN = AMOUNT
REALIZED - ADJUSTED BASIS
IRC 1001(C):
• “EXCEPT AS OTHERWISE PROVIDED
IN THIS SUBTITLE, THE ENTIRE
AMOUNT OF THE GAIN OR LOSS, . . .,
ON THE SALE OR EXCHANGE OF
PROPERTY SHALL BE RECOGNIZED”
IRC 351
• ONE OF THE EXCEPTIONS PROVIDED
IN SUBTITLE
• TAX FREE TRANSFER OF PROPERTY
TO A CONTROLLED CORPORATION.
TOPICS
•
•
•
•
RATIONALE FOR IRC 351
IRC 351(A)
ITS KEY ELEMENTS
EFFECT TO TRANSFEROR AND TO
TRANSFEREE
RATIONALE FOR IRC 351
• “CONTINUITY OF INVESTMENT” : IT
DOES NOT CLOSE THE
TRANSFEROR’S INVESTMENT WITH
SUFFICIENT ECONOMIC FINALITY
• A MERE CHANGE IN THE FORM OF
OWNERSHIP, WITHOUT “CASHING-IN”
OR “CLOSING-OUT” INVESTMENT.”
BEWARE
• NOT A PERMANENT EXEMPTION.
• NOT AN ELECTION.
• AVOIDANCE OF IRC 351 REQUIRES
INTENTIONAL FAILURE OF ONE OF
ITS ELEMENTS.
• IRC 351 APPLIES TO EXISTING
CORPORATIONS AS WELL.
IRC 351(A): GENERAL RULE
– NO GAIN OR LOSS SHALL BE
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 (AS
DEFINED IN SECTION 368(C)) OF THE
CORPORATION.
KEY ELEMENTS
• TRANSFEROR (transferring shareholder) /
TRANSFEREE (receiving corporation)
• PROPERTY
• SOLELY IN EXCHANGE
• STOCK
• IMMEDIATELY AFTER
• CONTROL
“PROPERTY”: IRC 317(a):
• “FOR PURPOSES OF THIS PART,
“PROPERTY” MEANS . . . .”
• HOWEVER, IRC 351 IS NOT WITHIN
SAME PART AS IRC 317
• PROPERTY = A LEGALLY DEFENSIBLE
PROPERTY RIGHT.
• REAL, PERSONAL, INTANGIBLE,
EQUITABLE INTERESTS.
IRC 351 (d): “PROPERTY” IS
NOT:
• SERVICES
• UNSECURED DEBTS OF TRANSFEREE
CORPORATION
• TRANSFEREE CORPORATION’S DEBT
INTEREST ACCRUEING TO
TRANSFEROR.
“PROPERTY” IS NOT
“SERVICES”
• RATIONALE:
– PREVENTS CONVERSION OF HUMAN
CAPITAL INTO FINANCIAL CAPITAL
– PREVENTS CONVERSION OF “ORDINARY
INCOME” INTO “CAPITAL GAIN”
• EXCHANGE OF SERVICES FOR
STOCK: FMV OF SERVICES OR STOCK
IS ORDINARY INCOME
STOCK FOR PAST SERVICES
• TRANSFEROR CAUSES CORP TO
TRANSFER STOCK TO EMPLOYEE
FOR PAST/FUTURE SERVICES.
• TREATED AS ISSUED TO ORIGINAL
TRANSFEROR FIRST.
• NO GOOD IF AN INTEGRATED
TRANSACTION.
TRANSFERS OF PROPERTY
AND SERVICES
• OK IF FMV OF TRANSFERRED
PROPERTY IS “MORE THAN SMALL
VALUE” WHEN COMPARED TO THE
AMOUNT OF FMV TRANSFERRED
SERVICES, E.G., NOT A SHAM.
Making a service TFOR an “IRC
351 TFOR”:
• TRANSFER OF PROPERTY > “SMALL
VALUE” IF:
– PROPERTY TRANSFERRED > 10% OF THE
VALUE OF STOCK TO BE RECEIVED FOR
SERVICES.
ESTABLISHED
CORPORATIONS:
• TRANSFER OF PROPERTY > “SMALL
VALUE” IF:
– PROPERTYTRANSFERRED > 10% FMV
STOCK OWNED BY TRANSFEROR.
NOTE:
• THESE ARE IN CONNECTION WITH
PLR’S REQUESTS. TODAY A PLR WILL
NOT BE ISSUED ON THAT QUESTION.
• STOCK FOR SERVICES WILL BE
TAXED AS ORDINARY INCOME
STOCK FOR SERVICES TO
OTHERS
• SERVICES TO A MEMBER OF THE
“CONTROL GROUP”
• PROHIBITION IS ONLY TO SERVICES
RENDERED TO CORP.
• BUT: LOOK FOR TRUE NATURE
– ORIGINAL TRANSFEROR WOULD HAVE
TO RECOGNIZE GAIN IF PAID WITH
STOCK WHOSE AB < FMV OF DEBT.
“SOLELY IN EXCHANGE FOR
STOCK”
• “SOLELY”: IT DOES NOT MEAN
“ONLY“
• IRC 351(b) SPECIFICALLY PERMITS
THE RECEIPT OF OTHER THAN
STOCK; “If subsection (a) would apply . . .
but for the fact that there is received, in
addition to the stock . . . other property . . .
.”
“OTHER PROPERTY” =
“BOOT”
• BOOT RECOGNITION = RECOGNIZE
BOOT UP TO THE GAIN
• BUT 351 TRANSACTION DOES NOT
FAIL.
BOOT ALLOCATION
• NECESSARY IF >1 PROPERTY
TRANSFERRED
• AKA “SEPARATE PROPERTIES
APPROACH”.
• REV. RUL. 68-55
EXAMPLE 1: BOOT
ALLOCATION (p.1)
• THREE PROPERTIES TRANSFERRED:
A, B, C
• FMV/AB OF PROPERTIES: 22K/40K,
33K/20K, 55K/25K
• FOR 100K IN STOCK AND 10K IN CASH
• HOW MUCH GAIN RECOGNIZED?
ALLOCATION (p.2):
•
•
•
•
•
FMV
22 33 55
% ON FMV
20% 30% 50%
ALLOC. BOOT:
2
3
5
ALLOC. STOCK: 20 30
50
TOTAL RECEIVED 22 33
55
ALLOCATION (p.3):
•
•
•
•
TOTAL RECEIVED 22 33
LESS AB
- 40 - 20
GAIN(LOSS) RLZD -18 13
RECOGNIZED
0
3
55
-25
30
5
“EXCHANGE”
• “PROPERTY” = A BUNDLE OF RIGHTS
• MUST EXCHANGE ALL SUBSTANTIAL
RIGHTS
• NOT A LICENSE, BUT NOT AN
“EXCHANGE” EITHER
• THUS, RETENTION OF SOME RIGHTS
IS PERMISSIBLE.
“STOCK”
• EQUITY INVESTMENTS
– VOTING PREFERRED
– NON-COMPENSATORY, NONASSIGNABLE, CONTINGENT RIGTHS W/
BUSINESS PURPOSE . REV. RUL. 66-112;
REV. PROC. 67-13
• NOT STOCK RIGHTS/WARRANTS
• RATIONALE: TO ENSURE
CONTINUITY OF INTEREST
“IMMEDIATELY AFTER”
• IT DOES NOT MEAN “SIMULTANEOUS
TRANSFERS”
WHAT DOES IT MEAN?
• OK TO HAVE TRANSFERS AT
DIFFERENT TIMES, AS LONG AS IT
WAS ALL PART OF AN INTEGRATED
TRANSACTION.
ISSUES
• DID EARLIER TRANSFERORS
TRANSFER PROPERTY WITH THE
EXPECTATION THAT LATTER
TRANSFERORS WERE GOING TO
TRANSFER PROPERTY ALSO?
• OR, WAS THE LATTER TRANSFERS
“OUT-OF-THE-BLUE”, E.G.,
UNPREMEDITATED?
“CONTROL”
• IRC 368(c): “ . . . AT LEAST 80 PERCENT
OF TOTAL COMBINED VOTING
POWER OF ALL CLASSES OF STOCK
ENTITLED TO VOTE AND AT LEAST 80
PERCENT OF THE TOTAL NUMBER OF
SHARES OF ALL OTHER CLASSES . . .
.”
INTERPRETATION OF
CONTROL:
• “TRANSFEROR GROUP” MUST OWN
80% OF THE AGGREGATE OF ALL
VOTING CLASSES AND 80% OF EACH
NONVOTING CLASS. Rev. Rul. 59-259.
EXAMPLE 2: 100 SHARES O/S
IN EACH CLASS
• VOTING CLASS A: X OWNS 40, Y
OWNS 40
• VOTING CLASS B: X OWNS 0, Y OWNS
80
• NONVOTING CLASS C: X OWNS 80; Y
OWNS 0
• NONVOTING CLASS D: X OWNS 0; Y
OWNS 80
ANSWER:
• “TRANSFEROR GROUP” OWNS 160/200
OF CLASSES A AND B, 80/100 OF
CLASS C, AND 80/100 OF CLASS D.
LOSS OF CONTROL
• NO 351 IF PRECONCEIVED PLAN OR
BINDING AGREEMENT
• GIFTS: OK B/C NO OBLIGATION FOR
GIFTS.
• BUT: TRANSACTION MUST BE GIVEN
ITS TRUE NATURE, E.G., GIFT TAX.
DISPROPORTIONATE
EXCHANGES
• NO SUCH REQUIREMENT
• BUT: TRANSACTION MUST BE GIVEN
ITS TRUE NATURE, E.G., GIFT TAX.
EFFECT ON TRANSFERORS IF
351:
•
•
•
•
NO GAIN NOR LOSS; IRC 351(a)
BOOT RECOGNITION: IRC 351(b)
ASSUMPTION OF LIABILITY : IRC 357
CARRYOVER AB: IRC 358(a)(1) AND (2)
ASSUMPTION OF LIABILITY:
IRC 357(a)
• EXCEPT AS PROVIDED IN
SUBSECTION (b) AND (c), IF
– (1) THE TAXPAYER RECEIVES PROPERTY
. . . WITHOUT RECOGNITION OF GAIN . .
. AND
THEN (IT) SHALL NOT BE
TREATED AS MONEY OR
OTHER PROPERTY . . . .
Tfror trfrs
•
•
•
•
•
•
PTY = 100; AB =60; MTG =40
TFEE: ASSUMES MTGE; C/S = 60
AR = 60 +40=100
LESS AB –60
GAIN REALIZED=40
GAIN RECOGNIZED = 0
Tfror trfrs
• PTY = 100; AB =60;
• TFEE: ASSUMES MTGE; C/S = 60 +
CASH 40
• AR = 60 +40=100
• LESS AB –60
• GAIN REALIZED= 40
• GAIN RECOGNIZED = 40
1ST EXCEPTION: IRC 357(b)(1)
• IF . . . IT APPEARS THAT THE
PRINCIPAL PURPOSE OFTHE T/P
– (A) WAS A PURPOSE TO AVOID FEDERAL
INCOME TAX . . . OR
– (B) IF NOT . . ., WAS NOT A BONA FIDE
BUSINESS PURPOSE, THEN SUCH
ASSUMPTION . . . SHALL . . . BE
CONSIDERED AS MONEY RECEIVED BY
THE T/P . . . .
BURDEN OF PROOF AND
EFFECT OF 357(b)(1)
• 357(b)(2): . . . BURDEN IS ON THE
TAXPAYER . . . BY THE CLEAR
PREPONDERANCE OF THE EVIDENCE
• EFFECT OF IRC 357(b)(1):
ASSUMPTION IS TREATED AS BOOT.
2ND EXCEPTION: IRC
357(c)(1)
• IRC 357(c) LIABILITIES IN EXCESS OF
BASIS
• “. . . IF THE SUM OF THE . . .
LIABILITIES ASSUMED . . . EXCEED
THE TOTAL OF THE ADJUSTED BASIS
OF THE PROPERTY TRANSFERRED . . .
THEN SUCH EXCESS SHALL BE
CONSIDERED A GAIN . . . .
Tfror trfrs
•
•
•
•
•
•
•
PTY = 100; AB =60; MTG =65
TFEE: ASSUMES MTGE = 65
AR = 65 MTGE + 35 C/S =100
LESS AB –60
GAIN REALIZED=40
GAIN RECOGNIZED = 5
``Excess of MTGE over AB
TWO EXCEPTIONS TO IRC
357(c)(1)
• IRC 357(C)(2)(A):
• IRC 357(c)(3)(B); 357(c)(3)(A):
1ST EXCEPTION: IRC
357(c)(2)(A)
• IGNORE IRC 357(c)(1) IF IRC 357(b)(1)
APPLIES.
2ND EXCEPTION:
• IF THE LIABILITY DID NOT
CREATE/INCREASE OF BASIS IN ANY
PROPERTY, EXCLUDE AMOUNT OF
THE FOLLOWING LIABILITIES FROM
THOSE ASSUMED:
– LIABILITY WHOSE PAYMENT WOULD
GIVE RISE TO A DEDUCTION
– LIABILITY FOR PAYMENT TO RETIRED
OR DECEASED PARTNERS
NOTE:
• IRC 357(c)(1) CONSIDERS ALL
LIABILITIES AND ALL AB
• TRIGGERS GAIN IRRESPECTIVE OF
HAVING ANY GAIN REALIZED
TRANSFEROR’S ADJUSTED
BASIS ON STOCK RECEIVED
• (a) IN THE CASE OF AN EXCHANGE
TO WHICH SECTION 351 . . . APPLIES– (1) NONRECOGNITION OF PROPERTY.
THE BASIS OF THE PROPERTY
PERMITTED TO BE RECEIVED . . . .
WITHOUT THE RECOGNITION OF GAIN
OR LOSS SHALL BE THE SAME AS THAT
OF THE PROPERTY EXCHANGED . . . .
IRC 358(a)(1)(A)
• (A) DECREASED BY
– (i) THE FMV OF ANY OTHER PROPERTY
(EXCEPT MONEY) . . .
– (ii) THE AMOUNT OF MONEY RECEIVED .
. . , AND
– (iii) THE AMOUNT OF THE LOSS TO THE
TAXPAYER WHICH WAS RECOGNIZED . . .
IRC 358(a)(1)(B)
• (B) INCREASED BY
– (i) THE AMOUNT WHICH WAS TREATED
AS A DIVIDEND
– (ii) THE AMOUNT OF THE GAIN TO THE
TAXPAYER WHICH WAS RECOGNIZED . .
.NOT INCLUDING ANY PORTION . . .
TREATED AS A DIVIDEND
AB AND ASSUMPTION OF
TRANSFEROR’S LIABILITY
– IRC 358(d)(1): “WHERE . . . ANOTHER
PARTY . . . ASSUMED A LIABILITY OF
THE TAXPAYER . . . , SUCH ASSUMPTION
. . .SHALL, FOR PURPOSES OF THIS
SECTION BE TREATED AS MONEY
RECEIVED”
– IRC 358(e): “EXCEPTION: THIS SECTION
SHALL NOT APPLY TO THE AMOUNT OF
ANY LIABILITY EXCLUDED UNDER
SECTION 357(c)(3).”
SUMMARY: TRANSFEROR’S AB
(STOCK)
•
•
•
•
ORIGINAL AB
+ GAIN RECOGNIZED
- FMV BOOT AND MONEY RECEIVED
- TRANSFEROR’S LIABILITIES
ASSSUMED BY THE CORP.
• ALLOCATE AB IF > 1 CLASS IS
RECEIVED
TRANSFEROR’S AB ON BOOT
RECEIVED
• IRC 358(a)(2)
• OTHER PROPERTY. THE BASIS OF
ANY OTHER PROPERTY (EXCEPT
MONEY) RECEIVED BY THE
TAXPAYER SHALL BE ITS FAIR
MARKET VALUE.
TRANSFEROR’S HOLDING
PERIOD
• SUBSTITUTED AB = SUBSTITUTED HP
EXAMPLE 3: DEBT ASSUMED
BY TFREE < AB
• TFROR TRANSFERS: FMV=$80K;
AB=$50K; MTG=$30K; FOR $50K IN
STOCK
• GAIN REALIZED=50K STOCK + 30K
RELEASE - 50K AB = $30K
• TFROR AB= 50K ORIGINAL - 30K
RELEASE = $20K ENDING AB
EXAMPLE 4: DEBT ASSUMED
BY TFREE > AB
• SAME, BUT NOW MTG=$60K
• GAIN REALIZED=20K STOCK + 60K
RELEASE -50K AB = 30K
• GAIN RECOG.: IF IRC 357(b) DOES NOT
APPLY, 357(c) REQUIRES
RECOGNITION OF $10K.
• TFROR AB=50K ORIGINAL -60K
RELEASE + 10K GAIN = $0 END AB
EXAMPLE 5: DEBTS ASSUMED
BY TFREE > AB
• FMV/AB: INV 10K/20K; LAND 40K/20K;
LAND MTGE 30K; FOR 20K IN STOCK
• GAIN REALIZED: 20K STOCK + 30K
RELEASE - 40K AB = 10K
• GAIN RECOGNIZED: $0
• NOTE THAT TOTAL AB=20K+20K=40K;
40K AB > 30K ASSUMPTION
EXAMPLE 5 CONTINUES: AB
& HP
• 40K ORIGINAL - 30K MTGE = 10K;
SPLIT 50/50 B/C OF NET FMV OF INV
AND LAND
• HP
– LAND: CARRYOVER / TACKED ON.
– INVENTORY: AS OF DATE OF
EXCHANGE
EXAMPLE 6: SAME BUT
LAND’S AB=$5K
• AGGREGATE AB= 20K + 5K = 25K
• 30K MTGE > 25K MTGE: RECOGNIZE
IRC 357(c)(1) GAIN OF $5K
• AB = ORIGINAL 25K -30K + 5K GAIN =
$0
EFFECT ON TRANSFEREE
CORP
• IRC 1032: “NO GAIN OR LOSS . . .
RECOGNIZED . . . ON THE RECEIPT OF
MONEY OR OTHER PROPERTY IN
EXCHANGE FOR STOCK . . . OF SUCH
CORPORATION. . . .”
• HENCE, EVEN IF NO 351 FOR
TRANSFEROR, TRANSFEREE
PROTECTED BY IRC 1032.
EFFECT OF IRC 311(b)(1)
• “IF (A) A CORPORATION DISTRIBUTES
PROPERTY . . . (O/T ITS DEBT) . . . TO A
SHAREHOLDER IN A DISTRIBUTION
TO WHICH SUBPART A APPLIES, AND
• (B) THE FMV > AB,
• THEN GAIN SHALL BE RECOGNIZED .
. . AS IF . . . SOLD . . . AT ITS FMV”
EFFECT OF DISTRIBUTING A
LIABILITY
• IRC 311(b)(2): TREATMENT OF
LIABILITIES. RULES SIMIALR TO THE
RULES OF SECTION 336(b) SHALL
APPLY . . . .”
• IRC 336(b): “IF ANY PROPERTY
DISTRIBUTED . . . IS SUBJECT TO A
LIABILITY . . . , THE FMV OF SUCH
PROPERTY SHALL BE TREATED AS
NOT LESS THAN THE . . . LIABILITY”
TRANSFEREE’S AB: IRC 362
• “IF PROPERTY WAS ACQUIRED . . . BY
A CORPORATION . . . IN CONNECTION
WITH . . . SECTION 351 . . . THEN THE
BASIS SHALL BE THE SAME AS IT
WOULD BE IN THE HANDS OF THE
TRANSFEROR, INCREASED IN THE
AMOUNT OF GAIN RECOGNIZED TO
THE TRANSFEROR . . . .”
TRANSFEREE’S HP; IRC
1223(2)
• CARRYOVER FROM TRANSFEROR
Summaries and Examples
Basis Computation for Sec. 351
Exchange (slide 1 of 2)
• Shareholder’s basis in stock:
Adjusted basis of transferred assets
+ Gain recognized on exchange
- Boot received
- Liabilities transferred to corporation
= Basis of stock received by shareholder
Basis Computation for Sec. 351
Exchange (slide 2 of 2)
• Corporation’s basis in assets:
Adjusted basis of transferred assets
+ Gain recognized by transferor shareholder
= Basis of asset to corporation
Assumption of Liabilities
(slide 1 of 2)
• Liabilities ARE treated as boot for
determining basis in acquired stock
Assumption of Liabilities
(slide 2 of 2)
• Liabilities are NOT treated as boot for gain
recognition unless:
– Liabilities > basis in assets transferred
• Gain recognized = Excess amount (liabilities - basis)
– Liabilities incurred for no business purpose or
as tax avoidance mechanism
• Boot = Entire amount of liability
Formation with Liabilities
Example
(slide 1 of 2)
Property transferred has:
Fair market value =
Basis
=
Realized Gain
=
$150,000
100,000
50,000
Formation with Liabilities
Example (slide 2 of 2)
Liabilities assumed by corp. (independent facts):
Business Business No Business
Purpose Purpose
Purpose
Liability:
$80,000 $120,000
$120,000
Boot
None
$20,000
$120,000
Gain
Recognized
None
$20,000
$ 50,000*
*(Gain is lesser of $50,000 realized gain or boot)
Shareholder’s Basis in Stock in
Last Example
Adjusted Basis of transferred assets:
$100,000
Liabilities assumed by corp. (independent facts):
Business Business No Business
Purpose Purpose
Purpose
Liability:
$ 80,000 $120,000 $120,000
Basis in assets
Transferred
$100,000 $100,000
$100,000
+ Gain recognized
None
20,000
50,000
- Liab. Transferred
(80,000) (120,000) ( 120,000)
Basis in stock
$ 20,000
-0$ 30,000
Corporation’s Basis in Assets
Received in Last Example
Liabilities assumed by corp. (Independent facts):
Business Business No Business
Purpose Purpose
Purpose
Liability:
$80,000 $120,000
$120,000
Basis of transferred assets:
$100,000 $100,000
$100,000
Gain recognized
by shareholder
None
20,000
50,000
Basis to Corp.
$100,000 $120,000
$150,000