Corporate TAX Outline PDF

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Outline with all major corporate tax issues for exam. Includes 351 transactions, redemptions, spin offs, mergers, liquidations, dividend distributions, stock exchanges, section 338 deemed asset purchases....

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CORPORATE TAX OUTLINE When we set up a juridical entity and set up a legal fiction as a real taxpayer, there is going to be a number of construct problems. How do we treat them as a real taxpayer when they are owned by someone? How do we ensure the corporation is taxed on the income the corporation earns? We want to do this because we want to preserve double taxation. Preserve taxation of the corporations profits and when the corporation distributed the earning to the shareholder, the shareholder has dividends. We want to make sure that they are taxed at the corporate level and again to the shareholders.  We must understand that we are wanting to preserve the integrity of corporate taxation of corporate income and then separate taxation of shareholder income.  Subchapter C is attempting to preserve the conundrum of having a corporate and shareholder level of taxation.  What are the corporate shareholder implications? What is the shareholder’s basis implications? We have to keep track at two levels.  Why is a C corporation called a C corporation? Because they are dealt with in subchapter C of title 26 of the Code—the 300’s. We have taxed corporations since 1909. The SC held that it was constitutionally valid to tax corporations even when there wasn’t an individual tax. Section 11 says that a corporation’s taxable income will be subject to a 21 percent rate—less than individual rate. When the earnings are distributed they are taxed again. We open up the thought of balancing the immediate time value of money of having earnings taxed at a lower rate but the price of poker is that I have to bare a second tax—but maybe not, can be minimized. Dividends will be subject to individual tax rate of the individual at the capital gains rate. Section 1h11 allows a shareholder who gets a qualified divided to be taxed at capital gains rate. Corporations that get a dividend are eligible for a dividend received deduction under section 234. If I do not set up a corporation then the individual would be taxed on the business income they earn and subject to ta 37 percent tax rate. But, section 199A allows for a deduction for QBI. So, the rate for someone that earns income directly is not going to be 37 percent. With the effect of the QBI deduction the rate is going to be 29.6 percent. Corporations are required to use the accrual method of accounting. Because a corporation is a separate entity, its use creates issues:  Transfer of property to/from the corporation to its shareholders  Treatment of interest held by stakeholders in the corporation  Dividends/profits distributed by the corporation to the shareholders  Redemption of shares  Liquidation of the corporation  Reorganization and purchase and sale of the corporation or the assets of a corporation. Publicly traded P must be treated as a corporation unless you fall under the exception for oil and gas P. Otherwise, a publicly traded company is going to experience subchapter C issues. Foreign entity with limited liability is treated as a corporation for federal tax purposes but there are some that are listed as per se corporations.

Check the box regulations  Today, regulations under 301.7701-3 provide taxpayers with the result.  If you set up a corporation under state law it will be taxed as a corporation for federal tax purposes—per se corporation (C corporation or potentially an S corporation).  If I set up an entity under state law—P, LLC or some other entity—the taxpayer can elect its classification. Can elect to be treated as a C corporation or not if you want. It is within your hand to elect. o If owned by two or more and no election, then it is a P. o If owned by one person, then treated as a DRE. Treated as if the owner is engaged in that business directly.  Check the box are called check the box because you literally check a box.  The default rule is that if an entity does not make an election and not corporation under state law it will be treated as a P or DRE if it is a domestic entity.  Publicly traded entities, except those that earn their income in oil and gas, are treated as a corporation. Strong v. Commissioner  We have a different question now. We have an entity, we know it is a corporation, we have already elected its status, what activities belong to the corporation?  Petitioner formed a P and transferred property to the corporation so mortgage loans could be made at a rate that satisfied the state usury laws. The corporation had losses and petitioner wanted to take the losses as his own and not the corporation. The partners of the P have this activity and many others and wanted the corporation to be treated as not having any activities. If the activities are outside of the corporation, then the losses belong to the individual partners.  We have a legal fiction created by individuals to conduct an activity but the individuals are saying they are really the ones that should be earning the income and losses directly.  The commissioner wanted to treat the corporation as the taxable entity responsible for the activities that were done by the corporation.  Two part test: o Is there a corporation? o Who’s income is it?  The court held that there was a business purpose and therefore there is a reason and an activity. If I create an entity that is not a sham and there is a business reason for this company to have a nexus with the activity, then it is like a black hole, that activity is that company’s. Bollinger v. Commissioner  Bollinger was different because although there was a corporation, the activity was not done as a principle of the activity.  In this situation, the income would be directed to the shareholders or the partners to the P that owned the corporation—Creek side.  They are trying to get around state usury laws with a juridical entity.  This case looked a lot like Strong, but the SC said that because there was a written agreement and the corporation was held out as an agent it could be treated as a true agent and the income was taxable to the real principles.

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If I have a written agent agreement, that says that I am working for the principle, the agent can act for the principle and we can apply that to any person, including a corporation. If the parties make it plain that their engagement in the activity is as an agent, then the court will respect that the corporation is not acting as the true owner of the activity it is engaged in. The court says you have to have a written agent agreement.

if I have an entity other than a corporation it is up to you to decide if it is going to be a corporation or not. If you make a corporation, it is out of your hands. If I have an entity that is a corporation then is that entity the one that engaged in the activity on its behalf? You then ask is it an agent for the true owner or is it a principle? Borge v Commissioner  This is the transfer pricing case. Petitioner conducted a poultry business with losses that exceed 50k. He then organized Danica and transferred the property to Danica. He was also a successful entertainer and agreed to perform for Danica and Danica would then pay petitioner 50k a year.  Danica was a corporation that took over the poultry business and the losses belonged to Danica and it had not other income. If Borge had checked the box as a tax nothing the losses would have gone to the shareholders.  Borge comes up with the idea of doing entertainment for Danica so that Danica gets the income and just gives him a salary of 50k.  The IRS says that it was two controlled companies and wants to reallocate the income to the right taxpayer. Using section 482, the commissioner wanted to reallocate the entertainment income back to Borge.  What hurt Borge in the treatment of Danica as being engaged in the entertainment business? o There was not paperwork. There needed to be a formal contract and the manner in which the negotiations were done by Danica and the persons paying for the entertainment business.  We will not assign income from the entertainment business from one related party to the other related party. Most 482 cases deal with a corporation and a shareholder who controlles the corporation. arrangments where loans are provided to a corporation that is struggling and has losses and I don’t trust adequate interest. I provide rent free property and the lender is getting depreciation without getting any rent. These are the type of activities where the courts have typically been involved in. Another 482 case is a shareholder getting the corporate benefits for free like using the corporate assets to go on vacation. Under 482 we would say that those are dividends to clearly reflect that the shareholder has received distributions of value from the corporation. if I am using corporate property for free or getting corporate benefits because of the relationship, then that is 482. Think about the fun cases like nba players who are going to get a lot of money and set up a personal corp to be the counterparty with the LA Lakers, and say I am really the employee of the corporation and if you want me to play with your team you need to deal with my corporation of

who I am an employee off. I am an employee of the corporation, and be an independent contractor with the NBA. In Johnson v. Commissioner accepted that and said that if up front the nba negotiates with that personal corporation and the player has a contract with that corporation and the formalities are followed so that everything is done by the book, we will respect that the corporation is the one earning the fees from the nba team and the player is only getting paid a salary by the corporation. Johnson v. Commissioner allowed that planning to be done if the corporate formalities were followed. In response congress passed 269A. Section 269A  This section says that if I form a corporation with a principle purpose of avoiding federal income tax, the performance of the services of that personal service corporation is on behalf of on one other entity—one nba team—and substantially all of the services provided by the corporation are performed by employees who own more than 10 percent of the stock, that income can be reallocated away from that personal services corporation.  So if my agent sets up this personal services corporation for two different players for two different teams, then I can avoid the mechanics of 269A. The principal purpose test is not something we talked about in this class.

Concepts of tax common law  The sham transaction  Substance over form analysis  The business purpose doctrine  The step transaction doctrine  Codified section 7701(o): economic substance Step transaction doctrine  A given result at the end of a straight path is not made different because it is reached by a devious path. If I engage in multiple steps to arrive to a result that is different than the direct path I could have taken, this doctrine says the courts or the IRS can tax it as if an alternative path were taken.  When applied, the tax treatment of several transaction is determined by examining the overall effect rather than giving effect to each of the several transactions in sequence.  Standard application: o Binding commitment test: step transaction doctrine applied if at the time the first step is entered into there was a binding commitment to undertake the later step.  If before I take step 1 I have to take step 2, the court is going to say I am going to tax you as if you went from A to B and not care that you took a side step. You will be taxed on the direct path if you were bound to take those intermediate steps. o Mutual interdependence test: step transaction doctrine applied if the steps are so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series. o End result test: step transaction doctrine applied if it appears that a series of formally separate steps are really pre-arranged parts of a single transaction

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intended from the outset to reach the ultimate result. The end result test is based upon the actual intent of the parties as of the time of the first step. We want to know when it is most likely to be applied and when is it least likely to be applied. When is it triggered? Which test applies makes a huge difference. Resequencing: as a general matter, the step transaction doctrine is not applied to simply resequence steps.

SECTION 351(a)  No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock if immediately after the exchange such person or persons are in control as defined under section 368c. o Control is 80 percent of vote or value—not 80 percent of all stock.  If we meet these requirements then no gain or loss is recognized.  What is the shareholders basis in the stock they received in the exchange? Section 358(a)—shareholder basis  358a says that in the case of an exchange to which 351 applies, the basis of the property permitted to be received without recognition of gain shall be the same as the property exchanged. o We are preserving the shareholders low basis. The shareholder has a substitute basis. So when the shareholder ultimately sells the stock for the FMV, then the shareholder will recognize that gain—but not right now. 1032—the corporation does not recognize gain or loss on a transfer of property  1032 says no gain or loss shall be recognized to the corporation on the receipt of money or other property in exchange for stock. The corporation does not have to receive the property in a 351 transfer—it recognizes no gain or loss regardless of the applicability of 351. 362(a)—the corporation’s basis in the transferred property  The corporation’s basis in the property can’t be FMV—there’s been no gain or loss and since no gain recognition there is no cost basis. So, we need a special basis rule.  362a says that if property is acquired by a corporation in which 351 applies, the basis will be the same as the basis in the transferor’s hands, increased by any gain recognized by the shareholder. The corporation steps into the shoes of the transferor for basis. They get a carryover basis from the shareholder’s basis in the property.  362(e)(2) limits basis if the aggregate basis in all property transferred to the corporation by any particular transferor to the aggregate FMV of the transferred property.  BIL property is not recognized ever, we cut back on this.  However section 362(e)(2)(C) allows the corporation and the shareholder to agree that the shareholder take a FMV basis in the stock and the corporation take a carryover basis in the property in the full amount.

Section 351 is not elective  If you meet the requirements of 351(a) then you are in the game.

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Section 351(b) says that if you don’t do a 351a transfer because the shareholder gets cash or other property in addition to stock, then gain shall be recognized but not in excess of the amount of the money received or the FMV of such property received and you can never get a loss. o If I receive boot in exchange for property, then I will recognize gain to the extent of the gain realized or the boot received, whichever is less. o I recognize the gain realized, or the boot received, which is less. o If I have 100 BIG and I get 10 of boot, I will recognize the lesser of the gain realized (the BIG) or the boot received, whichever is less.

Section 358 again  To the shareholders—basis of stock received shall be the same as the basis for the transferred property. Potential for double level of income taxation, i.e., to corporation and shareholder.  I can put property into the corporation real easy but hard to get out—lobster trap.  When a shareholder receives stock and other property in an exchange the shareholder’s basis in the stock is the basis in the property transferred, decreased by the boot received, and increased by the amount recognized.  Remember that basis will be the same as that in the transferred property unless the boot received exceeds the built in gain of the transferred property.  If the shareholder receives multiple classes of stock for transfer of property then basis is prorated on relative FMV of stock. o If I transfer property worth 100 with a basis of 20 and get one class of stock worth 20 and another class worth 80, I will take my 20 basis and give the stock worth 20 a prorated basis of (20x20/100) which is four and the same for the class with a FMV of 80 which would be 16 (20x80/100). See Rev. Rul. 85-164. Holding period  Shareholder’s holding period for stock is split for each share of stock as is dependent upon each asset per section 1223(1).  Shareholder has a tacked holding period when the shareholder transfers a capital asset or 1231 asset. Section 1223(1).  The corporation has a holding period under 1223(2) and they take a tacked holding period of what the shareholder transferor had. Definition of property  Includes cash  Transfer of shareholder’s own note is treated like cash  Includes accounts receivables and inventory as well as section 453 installment. Not property  Stock issued for services is not for property  Stock issued for corporation’s own debt not evidenced by a security is not for property.  Stock issued to pay interest on corporation’s debt is not for property  Stock issued for corporation’s own installment obligation is not for property.

Section 362(e)(2)—corporation’s basis when the transferor’s aggregate basis exceeds the FMV.  If property is transferred by a transferor under section a (which refers to section 351) and the transferor’s aggregate adjusted basis exceeds the FMV, the corporation’s aggregate adjusted basis shall not exceed the FMV in the property and the BIL will be prorated among the assets with BIL.  Example: o B transfers three assets to Y corporation with an aggregate FMV of 15500 but the basis in the properties is 17000. The corporation’s basis in the property received from B is capped at 15500. The 1500 excess has to be prorated among the BIL properties based upon their relative FMV. Assume for example that B transferred three properties to a newly formed Y corporation in exchange for all of the stock: a copyright, FMV of 4500, basis 3000; land FMV of 7000, basis of 9000; and a machine, FMV of 4000 and basis of 5000. The aggregate FMV of the three properties is 15500 and their aggregate basis is 17000, thus requiring a basis reduction of 1500 with respect to the land and the machine, the two properties with a basis that exceed the FMV (BIL). The land has a BIL of 2000 and the machine has a BIL of 1000. The 1500 basis reduction is allocated 2/3 to the land (2000 /(2000+1000)) and 1/3 to the machine (1000/(2000+1000)). Thus the basis of the land is reduced by 1000 (2/3 x 1500), from 9000 to 8000, and the basis in the machine is reduced by 500 (1/3 x 1500) from 5000 to 4500. Interactions of section 351 and section 118—non-issuance of stock  Section 351 applies to transfer by controlling shareholder who is in control immediately after the exchange even if no stock is issued. Issuance is a meaningless gesture. See Lessinger.  Section 118 provides that contributions of capital from non-shareholders are entitled to nonrecognition treatment as well. But 118h says that this does not apply if the contributor is a government entity. Business purpose requirement of 351  Business purpose requirement imposed in instances of transitory ownership.  But as a general rule if I want to take my existing business and put it in a corporation, this is looked as a business interest purpose for the fact that it is a business.  Business purpose has never been a bar for transfer of an operating business to a corporation that will conduct that business and shareholders hold continuing interest thereafter. Receipt of disproportionate stock  If I receive more stock than the value of the property contributed then something else is going on. I either got a dividend or am being compensated for services or something.  So when this happens, an excess amount of stock, then I have a separate transaction that needs to be tested.  Treas. Reg. § 1.1351-1(b)(1). 351(e)

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This section denies nonrecognition treat...