Tax Memo B

Instructions: The memo should not exceed two pages and students should use the tax memo template provided.

Tax Research Memo
Sample Format
Your Firm
Your Town and State
Date
Relevant Facts
This section should summarize the important facts of the research case. Only
include the relevant facts in a clear and concise manner.
Specific Issues
Identify the issue(s) and state the issue(s) in the form of a question.
Conclusions
Think of your conclusion as the “short” answer to your issue. The conclusion
section is the place to provide tax advice, recommend action(s) for the client to take,
or identify the need for additional information. There may not be a single “best”
alternative to the client’s issue so be sure to consider all applicable alternatives.
Support your conclusion by referencing back to the authority you discussed in the
discussion and analysis section.
Support
This section discusses the issue(s). Begin with the relevant code section(s).
Identify the code section, paraphrase what it says and then discus why it’s
important. Discussion of the relevant Treasury Regulations should follow. Identify the
regulation, paraphrase the important sections, and then address the importance of
the regulation given the facts.
The discussion
should continue by
reviewing relevant Treasury
pronouncements (Revenue Rulings, Revenue Procedures, Letter Rulings, etc.) and
cases. Be sure to include complete cite for each authority. Summarize the important
facts for the pronouncement/case and then compare the facts of the
pronouncement/case to the research facts. Discuss how the facts are similar or
different. Explain how each ruling or case supports or weakens the clients’ position.
Documentation is a very important part communicating tax research and all
statements or opinions should be substantiated with supporting cites. Supporting
cites should be to primary sources only except in rare or unusual situations.
Corporate Formation
• Sections 351 and 1032: Tax Deferral Mechanism
• Basis Rules
• Tax Planning Strategy: Section 362(e)
Corporation
Formation
Transaction
• Control required:
• Shareholders must own 80 percent after transfer
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for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or schoolapproved learning management system for classroom use.
Key Tax Concepts: Nonrecognition Rules
Sections 351 and 1032
• Section 351 treats the contribution of capital by the shareholder to the corporation as a
nonrecognition event to the shareholder
• Section 1032 treats the receipt of the contributed property to the corporation in
exchange for stock as a nonrecognition event to the corporation.
• Cash contributions in return for stock do not raise any significant tax consequences to
the transferor shareholders or the transferee corporation.
• Meaning there is no gain or loss on the transaction
• Caveat: This is a tax deferral mechanism meaning the shareholder nonrecognition is not
permanent. The gain or loss not recognized at the time of the exchange is only deferred
until such time as the shareholder later sells or exchanges the original stock received.
Structuring the Nonrecognition Transaction
• Under Section 351(a): Three requirements must be met in order to defer gain or loss on
the transaction.
• First, there must be a contribution of property
• Second, the contribution must be made solely in exchange for stock
• Third, the contributors (shareholders) must control the corporation immediately after
the exchange
Property
• Property includes cash and real or personal property.
• Property does NOT include past or future services in
exchange for stock. Payment for services regardless of the
form of compensation is taxable to the recipient as
ordinary income.
• 351(d) what is not property.
• Transfer requirement is broader than sale or exchange (ie;
contribution of a lease to use intellectual property)
Solely in Exchange for Stock:
“Continuity of Interest” Requirement
• Policy behind section 351: by taking only stock in return for
contributed property, the shareholders continue their relationship
with the contributed asset. This “continuity of interest” requirement
is the heart of section 351. Applies in the same way to reorganization
transactions. Treas. Reg. 1.368-1(b)
• In other words, the asets contributed are no different than they were
before and there will be little or no noticeable change in the
operation of the business.
• Boot received along with stock from the corporation will not
disqualify the transaction. The shareholder will be taxed on any
realized gain to the extent of the boot. 351(b)(1)
Control: The 80% Control Test
• Control also demonstrates continuity of interest
• There is no limit to the number of transferors or shareholders.
The public is considered to be part of the transferring control
group, so it includes minority shareholders aggregated with the
group.
• Section 368 (c) tests: The contributing shareholders as a group
must own
• stock possessing at least 80% of the total combined voting
power of all classes entitled to vote and
• At least 80% of the total number of shares of other classes
of stock
Example of Section 351 Capital Formation
Consequences of § 351 to Transferor
Receiving Stock and Boot in Exchange
• In general, no gain or loss to transferors:
• On transfer of property to corporation
• In exchange for stock
• If immediately after transfer, transferors are in control of corporation
• If boot (property other than stock) received by transferors
• Gain recognized up to lesser of:
• Boot received or
• Realized gain
• No loss is recognized Section 351(b)(2)
• After determining gain, it is then necessary to determine basis under Section
358 (a) and make certain adjustments
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except
for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or schoolapproved learning management system for classroom use.
Shareholder Transferor Basis in Stock Received Section 358
Computation for § 351 Exchange
Exchanged Basis Rule
Shareholder’s Basis of Stock Received in Exchange for Property
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except
for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or schoolapproved learning management system for classroom use.
Contributions with Assumption of Liabilities
Section 357
• In general, assumption of liabilities by corporation does not
result in boot to the transferor shareholder for gain
recognition purposes under 351, meaning assumption of a
liability by the corporation will not disqualify the tansaction
• But liabilities are treated as boot for determining basis in
acquired stock under Section 358
• Basis of stock received is reduced by amount of
liabilities assumed by the corporation
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except
for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or schoolapproved learning management system for classroom use.
Assumption of Liabilities Calculation
Tax Avoidance Problem 357(b)
• Liabilities are not treated as boot for gain recognition under
357(a)unless:
• Liabilities incurred for no business purpose or as tax avoidance
mechanism: Section 357(b)
• Boot = Entire amount of liabilities
• A transfers Purpleacre (FMV = $100,000, basis = $40,000),
subject to a mortgage of $50,000, to Newco for 80% of its stock.
The mortgage transfer has tax avoidance as a principal purpose.
A’s realized gain of $60,000 is recognized to the extent of the
amount of the mortgage treated as cash boot under IRC Sec.
357(b), rather than the amount of liabilities in excess of basis
which in this case would be $10,000 if no tax avoidance purpose.
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except
for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or schoolapproved learning management system for classroom use.
Negative Basis Dilemma Section 357(c)
Liabilities > basis in assets transferred
Gain Recognized= Excess amount (liabilities-basis)
IRC Sec. 357(c) is sometimes viewed as necessary to avoid the negative basis problem which would occur unless gain is recognized to the
extent liabilities exceed basis.
Example: A transfers Whiteacre (FMV = $100,000, basis = $30,000, mortgage = $70,000) to Newco for 80% of its stock. Without IRC Sec.
357(c), A’s recognized gain would be zero, and A’s stock basis would be:
• Basis of property transferred $30,000
• Gain recognized by A
-0-
• Liability acquired by Newco $70,000
• New basis—Newco stock
$40,000
• Can’t have a negative basis– IRC Sec. 357(c) triggers sufficient recognized gain to offset the negative basis.
• Example: Same as the previous example above, except IRC Sec. 357(c) does apply. A’s recognized gain is $40,000, and A’s basis is
calculated as follows:
• Basis of property transferred $30,000
• Gain recognized by A
$40,000
• Liability acquired by Newco
$70,000
• New basis—Newco stock
$-0-
Note Transferred in Excess of Basis
Treating a transferor’s promissory note as having a basis equal to its FMV–generally the face amount of the transferor’s
obligation–also solves the negative basis dilemma, by producing a basis similar to that produced under IRC Sec. 357(c),
i.e., no negative basis.
• Example: A transfers operating assets (FMV = $100,000, basis = $40,000), and liabilities of $70,000. In addition, A
transfers a personal promissory note to the corporation in the face amount of $30,000. If the promissory note is deemed
to have a basis equal to $30,000, no gain results under IRC Sec. 357(c), and A’s stock basis is as follows:
• Basis of operating assets transferred
$40,000
• Basis of note transferred (other property)
$30,000
• Gain recognized by A
$ -0-
• Liability acquired by Newco
$70,000
• New basis—Newco stock
$-0-
The face amount, (or FMV, if different) of a bona fide promissory note of the shareholder transferred to the corporation in
IRC Sec. 351 transaction should constitute additional basis and prevent application of IRC Sec. 357(c). This is not an
abusive situation and complies with the rationale and purpose of the incorporation provisions. Although no case has yet
determined such analysis as controlling, it seems to be the best interpretation of the statute.
Shareholder’s Transferor’s basis in stock
received
Transferee Corporate Basis Rules Section 362(a)
Substituted Basis Rule
• Unlike the shareholder exchange basis rule, the corporation receives a
substituted basis in the assets that it acquires from the shareholder.
• Section 358 provides that the basis in the hands of the corporation is
the same as it would be “in the hands of the transferor, increased in
the amount of gain recognized by the transferor” on the such transfer.
• It is a transferred basis where the corporation “merely steps into the
shoes” of the transferor.
Corporation Transferee Basis in Property Received Section 362
Basis Computation for § 351 Exchange
Corporation’s Basis in Property Received
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Corporate Transferee’s Basis in property
received
To summarize: Nonrecognition and Basis Rules
• The rules are not just limited to initial corporate formation but also apply to
all subsequent transfers to a corporation if the section 351 requirements are
met.
• Operating together, Section 351 shareholder nonrecognition rule and the
Section 358 basis rule establish a deferral rather than a permanent nonrecognition of the shareholder’s gain or loss with respect to assets
contributed to the corporation.
• Exchanged basis
• Operating together, Section 1032, the corporate nonrecognition rule and the
Section 362 basis rule provide for permanent nonrecognition of gain or loss
in the exchange.
• Substituted basis
Taxable Transfers to the Corporation
Sales of property at a loss: Sec. 351 does not apply
Anti-abuse provision
• §267(a)(1), losses from sale or exchange of property, directly or indirectly, are disallowed between related
parties. When the property is later sold to an unrelated party, any disallowed loss may be used to offset gain
on that transaction. However, if the related persons are corporations that are members of a controlled group,
the loss is deferred (as opposed to being disallowed) until the property is transferred outside the controlled
group as described in IRC §267(f).
• Example: A owns 65% of Corp B. A sells property to Corp B for $500. The property has an adjusted basis of
$800 at the time of sale. The loss of $300 is not allowable to A by reason of IRC §267(a)(1). Corp B later sells
this property for $1,000 to an unrelated party. Although Corp B’s realized gain is $500 ($1,000 minus $500, its
basis), Corp B’s recognized gain under IRC §267(d) is only $200, the excess of the realized gain of $500 over the
loss of $300 not allowable to A. Treas. Reg. §1.267(d) – 1(a)(4).)
• Example: Assume the same facts above except that Corp B later sells the property for $300 instead of $1,000.
Corp B’s recognized loss is $200. The $300 loss realized on the sale from A to Corp B is not recognized since
IRC §267(d) applies only to the non-recognition of gain and does not affect basis in the property.
Basis Adjustment for Loss Property
• A built-in loss exists if the property’s basis exceeds its fair market value at the
time of contribution.
• When built-in loss property is contributed to a corporation
• Aggregate basis in property may have to be stepped down so basis does not
exceed the F M V of property transferred
• Necessary to prevent parties from obtaining double benefit from losses
involved
• Step-down basis is allocated among assets with built-in loss
• Alternatively, if shareholder and corporation both elect, the basis reduction
can be made to the shareholder’s stock
• Built-in loss adjustment places loss with either the shareholder or the
corporation but not both
© 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except
for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or schoolapproved learning management system for classroom use.
Example of Corporate Basis in Assets Transferred with
Built In Loss Limitation and Tax Strategy
362(e)
Tax Memorandum B
The memo should not exceed two pages and students should use the tax memo template
provided. However, the answer should be a full 2 pages (double spaced, times new roman 12pt.,
1-inch margins) Do not repeat the question in the answer. Each memo must include an
explanation of the relevant code sections, regs and/or other relevant controlling authority such as
case law. Don’t just cite the rules or cases, explain them and their application to the specific facts
in the questions. Any memo with a similarity score exceeding 25% on Turnitin will be rejected
subject to the professor’s review and sole discretion.
Questions:
Does the transaction satisfy the nonrecognition rules of Section 351? Answer each hypothetical
separately. (hint: consider whether the steps in transaction disqualify the transaction. Also, the
regulations and revenue rulings may help here!)
Hypothetical #1:
T. Swit owns all of the stock of corporation Swit X and operates a second business similar to that
of Swit X through a sole proprietorship. Pursuant to an agreement between T. Swit and Alwyn
Inc., an unrelated corporation, T. Swit transfers all of the assets of the sole proprietorship to Swit
X in exchange for additional shares of Swit X stock. T. Swit then transfers all her Swit X stock to
Alwyn Inc. solely in exchange for voting common stock of Alwyn, Inc.
Hypothetical #2:
Parent Corporation owns 80 percent of the stock of a subsidiary, S1. An unrelated corporation
owns the remaining 20 percent. Parent transfers assets to S1 solely in exchange for additional
shares of S1 stock. As part of the same plan, S1 transfers the same assets to S2, a newly formed
corporation of which S1 will be an 80 percent shareholder. An unrelated corporation will own the
remaining 20 percent of the S2 stock.