Chapter 3 Notes Organization Strategies




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Chapter 3 Notes
Organization Strategies
I. Basic Organizational Forms

A. Unincorporated entities


Sole proprietorships
Advantages?

Disadvantages?


How are they taxed?
Partnerships (General, limited and LLPs)

What are the differences?


Advantages?


Disadvantages?

How are they taxed?

Limited Liability Companies – LLCs

Advantages?


Disadvantages?

How are they taxed?

B. Incorporated entities
C corps

Advantages?

Disadvantages?

How are they taxed?

S corps
Advantages?
Disadvantages?

How are they taxed?

II. Corporate Formations
If dividends are subject to double taxation, why not just loan money to corporation and deduct interest payments to avoid double tax issue?
Under the general rule of section 1001, the exchange of one piece of property for another is a taxable event. Gain or loss is recognized on the difference between the FMV of the property received and the taxpayer’s basis in the property given up.
However, there are a number of special rules that delay (or rarely eliminate) the recognition of gain or loss.
Code Section 351 is one of those special rules that requires deferral of realized gains (and losses).
The deferral is accomplished through a freezing of basis (adjusted for boot, debt relief and recognized gains). The contributor’s basis in the stock received is a substituted basis - that is the basis in the new stock is determined in reference to the basis of the old property transferred.

Requirements (under 351(a)):


(1). Property transferred solely in exchange for stock

How is property defined?


How is stock defined?
(2). Transferor or transferors control corporation after transfer

What is meant by control?

What if you receive something other than stock?

Under 351(b), the receipt of boot triggers recognition of gain (but not loss)


When boot is received, the basis of the stock received is the basis of the property transferred plus any gain recognized less the FMV of boot received.
The basis of boot received in a 351 transfer is always its FMV

Example 1:


T transfers property worth $250 with a basis of $150 to a corporation in exchange for all of its stock.

HW #4
Example 2:


T transfers property worth $250 with a basis of $150 to a corporation in exchange for stock plus a note for $50.

Example 3:


Assume that T’s property has a basis of $300.

HW # 6, 7, 8

III. Transfers of Property Subject to Debt

It is common for a business owner to have a new corporation assume their business liabilities in a 351 transfer. Generally, relief from debt is treated as if the person relieved of the debt had received cash.


However, 357(a) provides an exception for debt assumed in 351 transfers.
In general, the transfer of debt and subsequent relief from liability is not treated as boot and subsequently has no impact on recognition of gain.
Instead, the debt assumed is taken into account in determining the basis of the stock received in the transfer (reduces the basis of the stock received).
Exceptions:
(1). Tax avoidance transfers
Example 4:
A taxpayer mortgages property, pockets the cash and then transfers the property (with the new debt) to a controlled corporation. There is no business reason to transfer the debt to the corporation.
What happens?

HW # 10
(2). Debt in excess of basis


Example 5:
A transfers property worth $400 with a basis of $150 and subject to debt of $250 to a new corporation in exchange for all of its stock.

HW #9


(3). Exception:
Debt the transferor could have deducted had he or she paid it (for example accounts payable for a cash basis transferor) are disregarded for purposes of the determining the amount of liabilities assumed in a 351 transfer.

HW #11


IV. Tax Consequences to the Corporation
Under section 1032(a), the corporation does not recognize gain or loss
The corporation’s basis in property acquired in a 351 transfer is generally the basis of the property in the hands of the transferor (a carryover basis) increased by any gain recognized on the transfer.
V. Partnership and LLC formations:
Similar to Section 351and Section 1032(a), section 721 provides that neither a partner nor partnership recognizes gain or loss when a partner contributes property in exchange for a partnership interest.
As before, the deferral of gain is accomplished through basis – the partner’s basis in the pship interest (called the partner’s outside basis) is equal to the amount cash contributed plus the basis of any other property contributed.
The partnership’s tax basis in the property contributed (called the inside basis) is equal to the basis of the property in the hands of the contributing partner.
However, section 721 differs from Section 351 in 3 primary ways:

(1).


(2).

(3).


HW #14
VI. Disguised Sales
Although section 721 does not explicitly provide for gain recognition when partners receive “boot” there is an anti-abuse rule that applies when partners make contributions of appreciated property to a partnership and receive a cash distribution as part of the same transaction.

HW #16


VII. Partnership Assumption of Liabilities in a Section 721 Exchange

In general, the assumption of liabilities is treated as a nontaxable cash distribution that reduces the partner’s outside basis but does not cause recognition of gain.


The allocation of the liability to partners depends on whether the liability is recourse or nonrecourse

What is a recourse liability?

What is a nonrecourse liability?

Exception:


Cash distributions from a partnership (including deemed distributions through an assumption of liabilities) cannot decrease the partner’s outside basis below zero.
If a partner receives an actual or deemed cash distribution in excess of his outside basis, he must generally recognize the excess as a capital gain.

HW #18, A, B and C

However, if the assumed debt is nonrecourse, there is another special rule that prevents the recognition of gain by requiring the allocation of a preemptive share of the nonrecourse liability equal to any excess of the liability over the basis of the property.
HW # 18, D
VIII. Sales of Property to Controlled Entities
Section 351 and section 721 prevent losses from being recognized on contributions in exchange for corporate stock or a pship interest.
So, you might be tempted to structure a loss transaction as a sale
However,
Sections 267 and 707 prevent recognition of losses incurred on sales to controlled corporations and partnerhsips

HW #21
Gains on sales of capital assets to controlled corporations result in ordinary income to seller if the asset is depreciable by the buyer


Likewise, gains on sales of capital assets between a partner and a controlled partnership result in ordinary income unless the asset is a capital asset to the buyer

HW # 22






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