Corporation Formation Section 351 Strategies Tax Compliance and Planning. TCP CPA Exam
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In this video, we discuss
In this video, we discuss section 351 of corporation formation as covered on the tax planning and compliance CPA exam.
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When owners contribute property to a business, the tax implications vary depending on the structure of the business. Specifically, for corporations, both C and S types, the rules for whether such contributions can be made without incurring taxes are governed by Section 351 of the Internal Revenue Code (IRC).
Understanding Section 351 for C and S Corporations
Basic Criteria for Nontaxable Contributions:
Property Contributions: Owners can contribute property, which includes both tangible items and cash, to the corporation.
Stock Exchange: This contribution must be in exchange for stock in the corporation, not other forms of compensation.
Ownership Threshold: After the exchange, the contributors must own at least 80% of the corporation's stock, ensuring they have significant control over the company.
Tax Implications of Contributions Under Section 351
When Section 351 Criteria Are Met:
No Immediate Tax: Neither the contributing shareholder nor the corporation will recognize any immediate gain or loss from the contribution. This facilitates the smooth transfer of assets into the corporation without a tax penalty.
Basis Adjustment for Shareholder: The shareholder's basis in the newly acquired stock will be the same as their adjusted basis in the contributed property, minus any debts the corporation agrees to take on.
Basis for the Corporation: The corporation's basis in the received property will be the same as the shareholder's adjusted basis prior to the contribution. This ensures continuity in the tax treatment of the property.
When Section 351 Criteria Are Not Met:
Recognition of Gain or Loss: If the transaction does not meet the Section 351 requirements, the contributing shareholder must recognize any gain or loss. This could lead to immediate tax implications.
Adjustment in Basis: The basis of both the shareholder's stock and the corporation's property will increase by the amount of any gain recognized by the shareholder. This adjustment reflects the change in value and potential tax liability resulting from the contribution.
Section 351 of the Internal Revenue Code specifies the conditions under which the transfer of property to a corporation by shareholders in exchange for stock does not result in taxable income or loss. A key aspect of Section 351 is its definition of "property," which does not include services. This means when shareholders contribute only services in exchange for stock, such contributions are treated differently from property contributions:
Key Points:
Services Exclusion: Shareholders providing services in exchange for stock are not included in the Section 351 shareholder-contribution group. They must recognize income equal to the fair market value (FMV) of the stock received, establishing their stock basis at this FMV.
Impact on Control Test: The exclusion of service-only shareholders can affect the ability of the remaining group to meet the 80% control requirement necessary for a transaction to qualify under Section 351.
Mixed Contributions: Shareholders contributing both services and property may be included in the Section 351 group, provided the property's contribution is significant. Specifically, if the primary goal is to meet the Section 351 criteria, the property's value must not be minor compared to the services' value. A threshold often used is that the property's value should be at least 10% of the stock's value received for services to qualify.
When shareholders contribute property to a corporation in which the fair market value (FMV) is less than the tax basis—a situation known as contributing "built-in-loss" property—the ability to utilize the loss depends on whether the transaction meets the criteria of Section 351 of the Internal Revenue Code.
Key Principles:
Loss Utilization: Shareholders can only recognize and utilize the loss from contributing built-in-loss property if the transaction does not qualify under Section 351. This is because, under Section 351, the transfer of property to a corporation for stock, provided the contributors control the corporation post-transaction, is intended to be a non-recognition event for tax purposes, covering both gains and losses.
Section 351 Qualification: If the contribution does meet Section 351 requirements (i.e., the shareholders control more than 80% of the corporation after the transaction), then any built-in loss on the property contributed cannot be recognized at the time of contribution.
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When owners contribute property to a business, the tax implications vary depending on the structure of the business. Specifically, for corporations, both C and S types, the rules for whether such contributions can be made without incurring taxes are governed by Section 351 of the Internal Revenue Code (IRC).
Understanding Section 351 for C and S Corporations
Basic Criteria for Nontaxable Contributions:
Property Contributions: Owners can contribute property, which includes both tangible items and cash, to the corporation.
Stock Exchange: This contribution must be in exchange for stock in the corporation, not other forms of compensation.
Ownership Threshold: After the exchange, the contributors must own at least 80% of the corporation's stock, ensuring they have significant control over the company.
Tax Implications of Contributions Under Section 351
When Section 351 Criteria Are Met:
No Immediate Tax: Neither the contributing shareholder nor the corporation will recognize any immediate gain or loss from the contribution. This facilitates the smooth transfer of assets into the corporation without a tax penalty.
Basis Adjustment for Shareholder: The shareholder's basis in the newly acquired stock will be the same as their adjusted basis in the contributed property, minus any debts the corporation agrees to take on.
Basis for the Corporation: The corporation's basis in the received property will be the same as the shareholder's adjusted basis prior to the contribution. This ensures continuity in the tax treatment of the property.
When Section 351 Criteria Are Not Met:
Recognition of Gain or Loss: If the transaction does not meet the Section 351 requirements, the contributing shareholder must recognize any gain or loss. This could lead to immediate tax implications.
Adjustment in Basis: The basis of both the shareholder's stock and the corporation's property will increase by the amount of any gain recognized by the shareholder. This adjustment reflects the change in value and potential tax liability resulting from the contribution.
Section 351 of the Internal Revenue Code specifies the conditions under which the transfer of property to a corporation by shareholders in exchange for stock does not result in taxable income or loss. A key aspect of Section 351 is its definition of "property," which does not include services. This means when shareholders contribute only services in exchange for stock, such contributions are treated differently from property contributions:
Key Points:
Services Exclusion: Shareholders providing services in exchange for stock are not included in the Section 351 shareholder-contribution group. They must recognize income equal to the fair market value (FMV) of the stock received, establishing their stock basis at this FMV.
Impact on Control Test: The exclusion of service-only shareholders can affect the ability of the remaining group to meet the 80% control requirement necessary for a transaction to qualify under Section 351.
Mixed Contributions: Shareholders contributing both services and property may be included in the Section 351 group, provided the property's contribution is significant. Specifically, if the primary goal is to meet the Section 351 criteria, the property's value must not be minor compared to the services' value. A threshold often used is that the property's value should be at least 10% of the stock's value received for services to qualify.
When shareholders contribute property to a corporation in which the fair market value (FMV) is less than the tax basis—a situation known as contributing "built-in-loss" property—the ability to utilize the loss depends on whether the transaction meets the criteria of Section 351 of the Internal Revenue Code.
Key Principles:
Loss Utilization: Shareholders can only recognize and utilize the loss from contributing built-in-loss property if the transaction does not qualify under Section 351. This is because, under Section 351, the transfer of property to a corporation for stock, provided the contributors control the corporation post-transaction, is intended to be a non-recognition event for tax purposes, covering both gains and losses.
Section 351 Qualification: If the contribution does meet Section 351 requirements (i.e., the shareholders control more than 80% of the corporation after the transaction), then any built-in loss on the property contributed cannot be recognized at the time of contribution.
#cpaexaminindia #cpaexam #accounting
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