111

ACCY 272Session 03

Chapter 2 (D,E)

Formation of a Corporation

Text (Lind [6e]), pp. 85-115Problems, pp. 99-100,110-111

Cases, pp. 85-96[Peracchi],101-104[Hempt Bros.],111-114[Black & Decker]

Revenue Ruling, pp. 104-107[RR 95-74]

by Your name here

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D. Assumption of Liabilities [81-100]• Case: Peracchi v. Commissioner 143 F.3d 487 [85-96]• Problems [99-100]

E. Special Problems [100-115]1. Incorporation of a Going Business [100-111]

• Case: Hempt Brothers, Inc. v. United States 95 S.Ct. 44 (1974) [101-104]• Revenue Ruling 95-74 [104-107]• Problems [110-111]

2. Contingent Liability Tax Shelters [111-114]• Case: Black & Decker Corp. v. United States [111-114]

3. Intentional Avoidance of §351 [114-115]

Chapter 2 [85-115] – Table of Contents

3

D. Assumption of Liabilities [81-100]

4

D. Assumption of Liabilities [81-100]Case: Peracchi v. Commissioner 143 F.3d 487 [85-96]

Code –

Issue –

Facts –

Law and Analysis –

Holding –

5

D. Assumption of Liabilities [81-100]Problems [99-100]

1. A organized X Corporation by transferring the following: inventory with a basis of $20,000 and a fair market value of $10,000 and unimproved land held for several years with a basis of $20,000~ a FMV of $40,000 and subject to a recourse debt of $30,000. In return, A received 20shares of X stock (FMV $20,000) and X took the land subject to the debt.

(a) Assuming no application of §357(b), how much gain, if any, does A recognize and what is A's basis and holding period in the stock?

6

D. Assumption of Liabilities [81-100]Problems [99-100]

1. A organized X Corporation by transferring the following: inventory with a basis of $20,000 and a fair market value of $10,000 and unimproved land held for several years with a basis of $20,000~ a FMV of $40,000 and subject to a recourse debt of $30,000. In return, A received 20shares of X stock (FMV $20,000) and X took the land subject to the debt.

(a) Assuming no application of §357(b), how much gain, if any, does A recognize and what is A's basis and holding period in the stock?

(b) What result in (a), above, if the basis of the land were only $5,000?

7

D. Assumption of Liabilities [81-100]Problems [99-100]

1. A organized X Corporation by transferring the following: inventory with a basis of $20,000 and a fair market value of $10,000 and unimproved land held for several years with a basis of $20,000~ a FMV of $40,000 and subject to a recourse debt of $30,000. In return, A received 20shares of X stock (FMV $20,000) and X took the land subject to the debt.

(a) Assuming no application of §357(b), how much gain, if any, does A recognize and what is A's basis and holding period in the stock?(b) What result in (a), above, if the basis of the land were only $5,000?

(c) In (b), above, what is the character of A's recognized gain under Reg. § 1.357-2(b)? – Does this result make sense? – How else might the character of A's gain be determined?

8

D. Assumption of Liabilities [81-100]Problems [99-100]

1. A organized X Corporation by transferring the following: inventory with a basis of $20,000 and a fair market value of $10,000 and unimproved land held for several years with a basis of $20,000~ a FMV of $40,000 and subject to a recourse debt of $30,000. In return, A received 20shares of X stock (FMV $20,000) and X took the land subject to the debt.(d) In (b), above, what is X Corporation's basis in the properties received from A?

9

D. Assumption of Liabilities [81-100]Problems [99-100]

1. A organized X Corporation by transferring the following: inventory with a basis of $20,000 and a fair market value of $10,000 and unimproved land held for several years with a basis of $20,000~ a FMV of $40,000 and subject to a recourse debt of $30,000. In return, A received 20shares of X stock (FMV $20,000) and X took the land subject to the debt.

(a) Assuming no application of §357(b), how much gain, if any, does A recognize and what is A's basis and holding period in the stock?(b) What result in (a), above, if the basis of the land were only $5,000?

(e) What might A have done to avoid the recognition of gain in (b) above?

10

D. Assumption of Liabilities [81-100]Problems [99-100]

2. B organized Y Corporation and transferred a building with a basis of$100,000 and a fair market value of $400,000. The building was subject to a first mortgage of $80,000 which was incurred two years ago for valid business reasons. Two weeks before the incorporation of Y, B borrowed $10,000 for personal purposes and secured the loan with a second mortgage on the building. In exchange for the building, Y Corporation will issue $310,000 of Y common stock to B and will take the building subject to the mortgages.

(a) What are the tax consequences to B on the transfer of the building to Y Corporation?

11

D. Assumption of Liabilities [81-100]Problems [99-100]

2. B organized Y Corporation and transferred a building with a basis of$100,000 and a fair market value of $400,000. The building was subject to a first mortgage of $80,000 which was incurred two years ago for valid business reasons. Two weeks before the incorporation of Y, B borrowed $10,000 for personal purposes and secured the loan with a second mortgage on the building. In exchange for the building, Y Corporation will issue $310,000 of Y common stock to B and will take the building subject to the mortgages.

(b) What result if B did not borrow the additional $10,000 and, instead, Y Corporation borrowed $10,000 from a bank and gave B $310,000 of Y common stock, $10,000 cash and will take the building subject to the $80,000 first mortgage?

12

D. Assumption of Liabilities [81-100]Problems [99-100]

2. B organized Y Corporation and transferred a building with a basis of$100,000 and a fair market value of $400,000. The building was subject to a first mortgage of $80,000 which was incurred two years ago for valid business reasons. Two weeks before the incorporation of Y, B borrowed $10,000 for personal purposes and secured the loan with a second mortgage on the building. In exchange for the building, Y Corporation will issue $310,000 of Y common stock to B and will take the building subject to the mortgages.(a) What are the tax consequences to B on the transfer of the building to Y Corporation?(b) What result if B did not borrow the additional $10,000 and, instead, Y Corporation borrowed $10,000 from a bank and gave B $310,000 of Y common stock, $10,000 cash and will take the building subject to the $80,000 first mortgage?

(c) Is the difference in results between (a) and (b), above, justified?

13

D. Assumption of Liabilities [81-100]Problems [99-100]

2. B organized Y Corporation and transferred a building with a basis of$100,000 and a fair market value of $400,000. The building was subject to a first mortgage of $80,000 which was incurred two years ago for valid business reasons. Two weeks before the incorporation of Y, B borrowed $10,000 for personal purposes and secured the loan with a second mortgage on the building. In exchange for the building, Y Corporation will issue $310,000 of Y common stock to B and will take the building subject to the mortgages.

(d) When might there be legitimate business reasons for a C assuming a transferor's debt or taking property subject to debt?

14

E. Special Problems [100-115]1. Incorporation of a Going Business [100-111]

15

E. Special Problems [100-115]1. Incorporation of a Going Business [100-111]

Case: Hempt Brothers, Inc. v. United States 95 S.Ct. 44 (1974) [101-104]

Code –

Issue –

Facts –

Law and Analysis –

Holding –

16

E. Special Problems [100-115]1. Incorporation of a Going Business [100-111]

Revenue Ruling 95-74 [104-107]

Code –

Issue –

Law & Analysis –

Ruling –

17

E. Special Problems [100-115]1. Incorporation of a Going Business [100-111]

Problems [110-111]

• Architect, a cash basis TP, has been conducting a business as a sole proprietorship for several years. Architect decides to incorporate, and on July 1 of the current year he forms Design, Inc., to which he transfers the following assets:

Assets AB FMVAccounts Receivable $0 $60,000Supplies 0 20,000Unimproved Land 60,000 120,000

$60,000 $200,000• The land was subject to contingent environmental liabilities that Architect had not taken into account (i.e., had

not deducted or capitalized) for tax purposes at the time of the incorporation. The supplies were acquired nine months ago and their cost was immediately deducted by Architect as an ordinary and necessary business expense.

• In exchange, Architect receives 100 shares of Design common stock with a FMV of $100,000. In addition, Design assumes $70,000 of accounts payable to trade creditors of Architect's sole proprietorship and a $30,000 bank loan incurred by Architect two years ago for valid business reasons, and it assumed the environmental liabilities associated with the land.

• Design elects to become a cash method, calendar year TP. • During the remainder of the current year, it pays $30,000 of the accounts payable and collects $40,000 of the

accounts receivable transferred by Architect. • In the following taxable year, Design paid $20,000 in environmental remediation expenses that qualified for a

current deduction when paid or accrued under Section 162.

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E. Special Problems [100-115]1. Incorporation of a Going Business [100-111]

Problems [110-111](a) What are the tax consequences (gain or loss recognized, basis and holding period) of the incorporation to

Architect and Design, Inc.?

19

E. Special Problems [100-115]1. Incorporation of a Going Business [100-111]

Problems [110-111]

(b) Who will be taxable upon collection of the accounts receivable: Architect, Design or both?

20

E. Special Problems [100-115]1. Incorporation of a Going Business [100-111]

Problems [110-111]

(c) When Design pays the accounts payable assumed from Architect and incurs the environmental remediation costs, may it properly deduct these expenses?

21

E. Special Problems [100-115]1. Incorporation of a Going Business [100-111]

Problems [110-111]

(d) Assume that Architect is in the highest marginal individual tax bracket and Design, Inc. anticipates no significant TI for the current year:

• What result, if Architect decides to pay (and deduct) personally all the accounts payable. and transfers the accounts receivable to the C?

22

E. Special Problems [100-115]1. Incorporation of a Going Business [100-111]

Problems [110-111]

(e) Would your answers be any different if Architect had been an accrual method TP?

23

E. Special Problems [100-115]1. Incorporation of a Going Business [100-111]

Problems [110-111]

(f) Is Design, Inc. limited in its choice of accounting method (i.e., cash or accrual) or taxable year? See §§ 441; 448.

24

E. Special Problems [100-115]2. Contingent Liability Tax Shelters [111-114]

Case: Black & Decker Corp. v. United States [111-114]

Code –

Issue –

Facts –

Law and Analysis –

Holding –

25

3. Intentional Avoidance of §351 [114-115]