C Corporations: Advanced

Transcription

1 C Corporations: Advanced Edward K. Zollars Phoenix, Arizona Corporate Formation Module 1

2 Roberts Case The transferors were attorneys who had entered into a contingent fee arrangement with two beneficiaries of an estate whereby the attorneys would receive 35% of any recovery made by the beneficiaries from the estate. In order to facilitate the sale of property, the real estate was transferred to a corporation that issued shares to both the attorneys and the beneficiaries. The question was whether the transfer was a good IRC Sec. 351 exchange. The court held that this was a good IRC Sec. 351 for the attorneys since they had an equitable interest in the property that was transferred. The equitable interest was deemed to satisfy the "property" requirement. Example 1-7 Albert owns all of the 10,000 outstanding shares of Xenon Corporation with an FMV of $100,000. Barry wants to transfer property to Xenon in exchange for 5,000 of its unissued shares. Barry's transfer will not, standing alone, qualify under IRC Sec. 351 because it fails to meet the 80% control test. In order to help Barry, Albert tries to become part of the control group with Barry by transferring $10 to Xenon in exchange for 1 share of its stock. Since Albert's transfer is of relatively small value in comparison to the value of the stock he already owns, and his primary purpose is to qualify Barry under IRC Sec. 351, Albert's transfer of $10 is not counted. None of his stock counts for purposes of the control test, and Barry's transfer does not qualify under IRC Sec Had Albert transferred $10,000, he would be deemed part of the transferor group for control purposes.

3 NQ Preferred Stock a. The stockholder has the right to require the issuing corporation or party related to the issuing corporation to redeem or purchase the stock; b. The issuer or a related person is required to redeem or purchase the stock; c. The issuer or related person has the right to redeem or purchase and at the time of issuance it is more likely than not that such right will be exercised or d. The dividend rate is determined in whole or part by reference to interest rates, commodity prices, or similar indices. Example 1-13 Robert Curnutt is the sole shareholder of Paradise Corporation, which has $1,000 in earnings and profits. Robert's adjusted basis in his Paradise stock is $1,500 and its fair market value is $1,500. Robert transferred his stock in Tisa Corporation, a corporation of which Paradise owns 51% of the outstanding stock, in return for $750 of cash and $750 of Paradise stock. Robert is deemed under IRC Sec. 304(a) to have received a distribution of $750 from Tisa Corporation and to have transferred $750 worth of Paradise corporation stock to Tisa Corporation in a IRC Sec. 351 exchange. The $750 will be treated as a dividend to Robert if either Paradise or Tisa Corporation has $750 of earnings and profits.

4 Example 1-14 Bob Taft transfers property with a $300,000 basis to Paradise Corporation in exchange for all the corporation's stock, with a fair market value of $400,000, and a 3 year, $300,000 note, with $100,000 principal payable per year. The interest rate is fairly stated for IRC Sec purposes. In accordance with IRC Sec. 351(b), as discussed above, the $300,000 note is boot, and is eligible for installment treatment under IRC Sec In order to determine Taft's basis in his stock and note, his basis in the property he transferred to the corporation is first allocated to the stock to the extent such basis does not exceed the fair market value of the stock. In this case his basis in the property transferred, $300,000 is less than the fair market value of the Paradise stock i.e. $400,000, he received in the exchange. Thus there is no "excess basis." Accordingly Taft's basis in the Paradise stock and the note is $300,000 and zero, respectively. Paradise's basis in the property is $300,000 and will be increased as Taft recognizes gain as the notes are paid. If Taft receives a $100,000 payment on the notes in year two, all of the payment would be gain to Taft and Paradise's basis in its property will increase by the $100,000. However, if the note is $600,000 and the Paradise stock is worth $100,000 there s a different result. Here we do have excess basis, $200,000, since Taft's basis in his property, $300,000, exceeds the fair market value of the Paradise stock he received, $100,000, by $200,000. Accordingly Taft's basis in his Paradise stock is $100,000 and his basis in the note he received is $200,000. As Taft recognizes gain, Paradise's basis in its property will increase. Example 1-16 In a good IRC Sec. 351(a) exchange, Larry Parker transfers to Case corporation property with a fair market value of $100,000 and an adjusted basis of $60,000. As part of the exchange Larry receives Case stock with a fair market value of $70,000, cash of $20,000, and Case assumes $10,000 of Larry's liabilities. Larry's realized gain is computed as follows: Case Stock--Fair Market Value $ 70,000 Cash $ 20,000 Liabilities Assumed $ 10,000 Amount Realized $100,000 Adjusted Basis $ 60,000 Gain Realized $ 40,000 IRC Sec. 357(a) provides that the $10,000 liabilities assumed will not be treated as boot. Therefore boot will be only the $20,000 cash. Of the gain realized of $40,000, only $20,000 will be recognized. The $10,000 assumed liability simply reduces Larry s basis in the stock.

5 Improper Motive In Eck v. U.S., 70-2 USTC para (D. N.Dak. 1969) the taxpayer incurred the debt about one month before the IRC Sec. 351 transfer. The transferor retained the proceeds but the corporation assumed the debt. The transferor rationalized the liability as his attempt to reduce the corporation's value so as to make it more affordable for an employee buyout. The court found that the shareholder's motive was entirely personal. Improper Motive In ISC Industries, Inc. v. Comm., 30 T.C.M (1971) the taxpayer, in the consumer finance business, acquired a corporation engaged in the bakery business. Upon acquiring the bakery the taxpayer merged the bakery into his original corporation. The bakery was mortgaged at the same time. The bakery was then dropped down into a subsidiary of the parent in an attempt to avoid creditors of the bakery attaching the assets of the consumer finance business. The proceeds of the mortgage were used in the consumer finance business. The Tax Court held that the primary purpose of the liability was to protect the taxpayer's finance business.

6 Example 1-18 Bill Eipp is a cash basis taxpayer who incorporates his business in a good IRC Sec. 351 exchange. Bill transfers all of his assets, with an aggregate basis of $300,000, accounts payable which when paid would give rise to a deduction of $500,000, and other liabilities of $200,000. Since the $500,000 of accounts payable, when paid, gives rise to a deduction, they will not be counted as liabilities under IRC Sec. 357(c). Hence in this case liabilities do not exceed basis. Allocate Gain to Multiple Assets Marvin Kipp transfers inventory and capital assets to Paradise Corporation in a IRC Sec. 351 exchange. The basis and values of the properties are as follows: Property Basis Fair Market Value Inventory $ 20,000 $ 50,000 Capital Assets $120,000 $100,000 Totals $140,000 $150,000 As part of this exchange, Paradise Corporation assumes Kipp's liability of $146,000. This results in a taxable gain of $6,000, the excess of the liabilities assumed, $146,000, over the basis of the properties transferred, $140,000. The $6,000 gain is allocated in the following manner: $6,000 X $50,000/$150,000 = $2,000 = gain allocated to inventory $6,000 X $100,000/$150,000= $4,000 = gain allocated to capital assets. Note that even though the entire gain is attributable to inventory, part of the gain must be allocated to capital assets. Sometimes the transfer of a liability could be subject to both IRC Sec. 357(b) and IRC Sec. 357(c). In such cases IRC Sec. 357(c)(2) provides that IRC Sec. 357(b) prevails over IRC Sec. 357(c).

7 BASIS OF STOCK RECEIVED IN A SECTION 351 TRANSFER Adjusted basis of the property transferred - Boot received (including liabilities transferred) + Gain recognized = Basis of stock received BASIS OF ASSETS RECEIVED BY THE CORPORATION IN A SECTION 351 TRANSFER Adjusted basis of the property to the transferor + Gain recognized by the transferor on the exchange = Aggregate basis of the property received.

8 Allocate Gain Among Multiple Assets APPROACH #1 APPROACH #2 APPROACH #3 Pre-transfer Basis of Property/total Pre-transfer Bases of All Properties Transferred Fair Market Value of The Particular Property/total Fair Market Value of All Properties Appreciation of The Particular Property/total Appreciation of All Properties Partnership to Corporation SITUATION 1 Partnership X transfers all of its assets to newly formed corporation R in exchange for all the outstanding stock of R and the assumption by R of X's liabilities. X then terminates by distributing all the stock of R to X's partners in proportion to their partnership assets.

9 Partnership to Corporation SITUATION II Y distributed all of its assets and liabilities to its partners in proportion to their partnership interests in a transaction that constituted a termination of Y under IRC Sec The partners then transferred all the assets received from Y to newly formed corporation S in exchange for all the outstanding stock of S and the assumption by S of Y's liabilities that had been assumed by the partners. Partnership to Corporation SITUATION III The partners of Z transferred their partnership interests in Z to newly formed corporation T in exchange for all the outstanding stock of T. This exchange terminated Z and all of its assets and liabilities became assets and liabilities of T.

10 Shareholder 351 Statement 1. Name and employer EIN of the transferee corporation 2. The date of the transfer 3. The aggregate FMV and basis of the transferred assets and 4. The date and control number of any Private Letter Ruling from the IRS (Reg (d). Corporation 351 Statement 1. The name and EIN or SSN of each significant transferor 2. The date or dates of the transfers 5. The aggregate FMV and basis of the transferred assets and 6. The date and control number of any Private Letter Ruling from the IRS (Reg (d).

11 Corporate Dividend Distributions Module 2 316(a) Tax Dividend any distribution of property made by a corporation to its shareholders (1) out of its earnings and profits accumulated after February 28, 1913, or (2) out of its earnings and profits of the taxable year (computed at the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of earnings and profits at the time the distribution is made.

12 Form 5452 (Rev ) Worksheet for Figuring Current Year Earnings and Profits Page 4 Date Incorporated: Method of Accounting: Retained Earnings Shown in Books Debit Credit Earnings and Profits Current Year Debit Credit Accumulated Earnings and Profits Credit Balance Key Form 5452 Balance forward 12/31/ Year 1 Taxable income* from Form 1120, line 28 (or comparable line of other income tax return) 2 Federal income taxes per books and tax return 3 Excess of capital losses over capital gains (tax basis) 4 Depreciation adjustment on earnings and profits (section 312(k)) 5 Depreciation adjustment on sale of property 6 Total itemized expenses from line 5, Schedule M-1 a Travel and entertainment b Life insurance premium greater than cash surrender value (CSV) c Nondeductible interest paid for tax-exempt bonds d Contributions carryover e Other (list separately) 7 Total itemized income from line 7, Schedule M-1 a Life insurance proceeds greater than CSV b Bad debt recovery (not charged against taxable income) c Tax-exempt interest on municipal bonds d Other (list separately) 8 Refund of prior year Federal income taxes 9 Reserve for contingencies 10 Additional adjustments: 11 Totals Current Year Earnings and Profits Cash Distributions: From current year earnings and profits From accumulated earnings and profits Total distribution from earnings and profits From other distribution Total distribution % % % % 100% Total cash distributions Totals Current year change Balance forward 12/31/ * Taxable income before net operating loss deduction and special deductions. Form 5452 (Rev ) Calculation of E&P CURRENT YEAR'S TAXABLE INCOME OR LOSS + EXEMPT AND NONDEFERRABLE INCOME - ITEMS NOT DEDUCTIBLE IN COMPUTING TAXABLE INCOME + DEDUCTIONS NOT PERMITTED IN COMPUTING E&P = CURRENT EARNINGS AND PROFITS (CAN BE NEGATIVE OR POSITIVE)

13 Positive Adjustments tax-exempt interest Negative Adjustments federal income tax deferred gain on installment sales nondeductible penalties and fines dividends received deduction bribes to public officials excess of accelerated depreciation in excess of straight line expenses between related parties not deductible under IRC Sec. 267 excess of ACRS depreciation over ADS straight line depreciation; excess of MACRS depreciation over alternative (straight line) depreciation with 12 year life for personal property with no class life interest expense related to the production of tax exempt income excess of LIFO cost of goods sold over FIFO cost of goods sold life insurance premiums when the corporation is the beneficiary 4/5ths of any IRC Sec. 179 deduction taken during the year travel, entertainment, and gift expense that do not meet the substantiation requirements of IRC Sec. 274(d) excess of deductions for construction period interest and taxes over the amortization of such costs Percentage of meals and entertainment disallowed as a deduction under IRC Sec. 274(n) excess of depletion taken over cost depletion other expenses disallowed to the corporation as the result of an IRS audit Positive Adjustments increases in cash surrender value of life insurance when the corporation is the beneficiary of the policy Negative Adjustments nondeductible losses between related parties under IRC Sec. 267 proceeds of life insurance when the corporation is the beneficiary charitable contributions greater than the10% limit amortization of organization and circulation expenditures excess capital losses for the year not deductible net operating loss deductions carried over from other years gains on sales of depreciable property to the extend that accelerated depreciation exceeds the straight line method used for computing increases in E&P federal income tax refunds gains on sales of depletable property to the extend that depletion taken exceeds cost depletion recoveries of bad debts and other deductions--if they are NOT included in taxable income under the tax benefit doctrine 1/5th of any immediate expensing deduction under IRC Sec. 179 income based on the percentage of completion method rather than the completed contract method foreign taxes paid that have been treated as credits on the corporation's tax return in the year they are reflected in taxable income: charitable contribution carryovers, capital loss carryovers, and other timing differences since they reduced E&P in the year they originated

14 E&P Decision Table Current E&P Positive Allocate among all distributions on a pro rata basis Accumulated E&P Positive Allocate among distributions in chronological order Current E&P Negative Prorate on a daily basis against any accumulated E&P on the date of the distribution Accumulated E&P Negative Ignore all distributions are dividends to the extent of their share of current E&P Example 2-6 At the beginning of 2009, Rottweiler Corporation had accumulated E&P of $40,000. Current E&P for 2009 was $27,000. Ernst Doberman, the sole shareholder, has a basis of $15,000 in his stock. During the year, Rottweiler made cash distributions to Doberman of $30,000 on April 1 and $60,000 on October

15 Example 2-6 Date Amount Current E&P Excess Accumulated E&P Return of Capital Sale 4/1 $30,000 $ 9,000* $21,000 $21, /1 $60,000 $18,000* $42,000 $19,000 $15,000 $8,000 * $30,000 X $27,000 = $9,000 $30,000 + $60,000 * $60,000 X $27,000 = $18,000 $30,000 + $60,000 Both distributions are deemed to consist of their allocable share of current E&P. The first distribution of April 1 distribution represents a $9,000 distribution from current E&P while the October 1 distribution represents a $18,000 of current E&P. Accumulated E&P is allocated on a chronological basis. As a result $21,000 of the $40,000 balance is allocated to the remaining portion of the April distribution, and the remaining accumulated E&P of $19,000 is allocated to the October 1 distribution. Thus the entire $30,000 distribution on April 1 is treated as a dividend while only $37,000 of the October 1 distribution of $60,000 is a dividend. The remaining $23,000 balance of the October 1 distribution is considered a return of capital. Example Assume that instead of $27,000 of positive current E&P there is ($27,000) of negative current E&P. Amount Current E&P Available E&P 4/1 30,000 (6,658)* = 33,342 * 90/365 X (27,000) = (6,658) Amount Current E&P Available E&P 10/1 60,000 (13,463)* = 0 * 182/365 X (27,000) = (13,463) Thus all of the first distribution is a Dividend and all of the second is return of capital or capital gain.

16 Distribution with Debt Example Rottweiler Corporation made a distribution to its sole shareholder Bert Nelson of land with a FMV of $150,000. The corporation's basis in the land was $60,000. Bert took the property subject to a mortgage of $20,000. The amount of the distribution is the $150,000 reduced by the $20,000 mortgage, i.e. $130,000. Bert's basis in the land is $150,000. E&P Two Classes of Stock Attack Dog, Inc. has two classes of stock, common and preferred. The corporate charter provides that the preferred shareholders are entitled to a $100,000 distribution each year before any distribution can be made to the common shareholders. Assuming that for the year ended December 31, 2009, Attack Dog has E&P of $150,000, and Attack Dog made a distribution of $100,000 to its preferred shareholders and $100,000 to its common shareholders in 2009, the distribution to the preferred shareholders is a dividend in its entirety and the distribution to the common shareholders is a dividend to the extent of the remaining E&P, $50,000.

17 E&P With a Redemption Attack Dog Corporation has no current E&P and accumulated E&P of $20,000. On July 1, 2009, Attack Dog redeems 20% of its outstanding common stock. On January 1, and August 1, of 2009, Attack Dog makes ordinary distributions of $14,000 and $6,000, respectively. The allocation of E&P is as follows: Distribution Distributions From Current E&P Reduction of Accumulated E&P Dividend January 1 0 $14,000 $14,000 July 1 0 $ 1,200* August 1 0 $ 4,800* $ 4,800 *As of July 1, 2009, the corporation's E&P equals $6,000 i.e. $20,000 minus the $14,000 distribution. On July 1, the redemption results in a contraction of the E&P by the percentage of the stock redeemed, limited by the amount of the redemptive distribution. Accordingly since E&P equals $6,000, 20% of that, or $1,200, is a reduction in E&P. On August first the E&P account equals $20,000 - ($14,000 + $1,200) = $4,800. Accordingly the August 1 distribution results in a dividend of $4,800. Timing of Counting E&P 1. The declaration date of the distribution by the corporation 2. The date as of which the stock must be held in order for the owner to be entitled to receive the distribution i.e., the record date 3. The date on which a corporation physically makes payment or makes the payment available to the shareholder i.e., the date of physical distribution 4. The date of actual or constructive receipt of the distribution by a particular shareholder

18 Distribution of Property Rottweiler Corporation distributed land worth $100,000, with a basis of $20,000, and equipment with a FMV of $30,000 and a basis of $45,000, to its sole shareholder Simon Whisper. Rottweiler must recognize the $80,000 gain on the land but cannot recognize the loss on the equipment. Distribution of Property E&P Effect Rottweiler Corporation distributes land worth $50,000, with a basis of $10,000. Since the corporation recognizes a gain under IRC Sec. 311(b) of $40,000, that gain increases E&P by $40,000. The E&P account is then reduced by the FMV of the property, $50,000. Thus Increase in E&P by gain recognized $40,000 Decrease in E&P by fair market ($50,000) Net decrease in E&P ($10,000) 2-11

19 Distribution of Property E&P Effect In 2009, Rottweiler Corporation, which has $1 million of E&P, distributed land with a FMV of $60,000 and a basis of $80,000 to its sole shareholder, Simon LaGree. The land was subject to a mortgage of $30,000. To account for that distribution Rottweiler first reduced its E&P by the basis of the property, $80,000, then increased E & P by the amount of the assumed mortgage; $30,000. The net reduction to E&P is $50, Distribution of Property E&P Effect In 2009, Pomeranian Corporation distributed a building with a FMV of $100,000 and a basis of $70,000 to its sole shareholder Diane Kirby. The property is subject to a mortgage of $40,000. The E&P would be adjusted as follows: Increase in E&P by Gain Recognized $ 30,000 Decrease E&P by the Fair Market Value of the Property $100,000 Increase E&P by The Amount of the Liability $ 40,000 Net Decrease in E&P $ 30,

20 Corporation s Own Obligations Rottweiler Corporation, with $1 million of E&P, distributed its own 5 year notes to its shareholders. The notes had a principal amount of $1 million, bore interest at 4%, required payment of interest monthly, and payment of principal at maturity. Because the Corporation had a poor credit rating, the FMV of the notes was determined to be $780,000. E & P is reduced by $780,000, the shareholders report $780,000 of dividends, and their basis in those notes is $780, Exceptions to General Rule on Stock Dividend 1. A distribution which, at the election of any of the shareholders, is payable either in corporate stock or property 2. A distribution which has the result of distributing property to some shareholders, while others secure an increase in proportionate share of the assets or earnings and profits of the corporation 3. A distribution of preferred stock to some common shareholders and common stock to others 4. A distribution made with respect to preferred stock--other than an increase in the conversion ratio of convertible preferred stock - - made solely to take account of a stock dividend or stock split with respect to the stock into which such convertible stock is convertible 5. A distribution of convertible preferred stock, unless the evidence indicates that the result will not be a disproportionate distribution

21 Stock Sale Dividend Rules Stock is sold--dividend is both declared and paid after the sale Stock is sold--after the declaration date and after the record date Dividend is income to the purchaser Dividend is income to the seller Stock is sold between the time of declaration and the time of payment of the dividend purchaser becomes entitled to the dividend Dividend is income to the purchaser Factors for Legitimate Loan 1. Whether the taxpayer/shareholder is a controlling shareholder or a minority shareholder 2. Whether the corporation has a history of making dividend distributions 3. The size of the loans relative to the dividends paid, if any 4. Whether appropriate documentation exists to substantiate the loan as an unconditional obligation which must be repaid 5. Whether security or collateral was given for the loan 6. What efforts the corporation has taken to enforce payment in the event of default or threat of default 7. Whether interest is fairly stated 8. Whether the corporation has positive or negative E&P 9. Whether the shareholders have attempted repayment

22 Corporate Repayment Shareholder Loan 1. Whether the books and records characterize the transaction as a loan 2. Whether the corporation's tax return characterize the transaction as a loan 3. Whether the corporation has a history of repayment 4. Whether the documentation exists to substantiate the loan 5. Whether interest has been paid on the loan 6. What was the subjective intent of the parties Dividends Received Deduction Corporate dividend recipient owns less than 20% of payor corporation Corporate dividend recipient owns at least 20% but less than 80% Payor and payee corporations are members of an affiliated group 70% 80% 100%

23 Items Disregarded in Computing the DRD The DRD NOL carryovers NOL carrybacks Capital loss carrybacks STEP #1 STEP #2 Multiply the dividends received by 70%. This is the tentative dividends received deduction (DRD) Compute the tentative taxable income for the current year, using the tentative DRD from step #1 Total revenues (including dividend income) Less: total expenses Equals: taxable income before DRD Less DRD (step #1) Equals: tentative taxable income (loss) If the tentative taxable income is positive, the taxable income limit may apply. If the taxable income is negative, there is no taxable income limit. STEP #3 STEP #4 Compute the taxable income limit Start with: taxable income before DRD (step #2) Add: NOL carryovers or carrybacks reflected in taxable income Add: any capital loss carrybacks from later years reflected in taxable income Equals: taxable income before DRD Multiply by 70% Equals: taxable income limit Compare the tentative DRD (step #1) to the taxable income limitation (step #3). Choose the smaller amount. This is the corporate dividends received deduction.

24 EXAMPLE: Dividends Received (from 2% owned Domestic Corp.) 100,000 Taxable Income without DRD 70,000 70% of Dividends 70,000 70% of TI 49,000 DRD (49,000) Taxable Income 21,000 Dividends Received from 2% owned Domestic Corp 100,000 Taxable Income without DRD 69,999 70% of dividends 70,000 70% of TI 48,000 DRD 70,000 Taxable Income ($ 1) Since the full DRD would result in a loss, the income limit does not apply. On October 1, 2003, Rottweiler corporation received $50,000 of dividends from Ford Motor Company. Rottweiler had purchased the Ford stock for $100,000, all of it borrowed, in Assuming the average unpaid balance on the debt between the dividend dates was $60,000. Rottweiler's average indebtedness percentage under these facts is 60%. The DRD is limited to: Dividends received on debt financed portfolio stock $50,000 Percentage (70% X (100% - 60%) = 28% DRD $14,000

25 Corporate Redemptions Module 3 General Redemption Rules 1. Redemptions must be made only out of surplus rather than capital and 2. Redemptions cannot be made if the corporation will thereby be rendered insolvent

26 IRC Redemption Types A. A redemption which is not essentially equivalent to a dividend B. A redemption which is substantially disproportionate to the shareholder being redeemed C. A complete termination of the shareholder's interest in the corporation, or D. A partial liquidation Reattribution Rules John owns 60% of BuzzCo that owns 100 shares of Jobco. Under the attribution rules John owns 60 shares of Jobco through Buzzco. If John s wife, Samantha, owned 30 shares of Jobco that were redeemed, one would have to determine her ownership before and after the redemption. Before the redemption she owned 30 shares directly and 60 shares through attribution/reattribution. After, she owns 60 shares through attribution/reattribution. (The 60 shares are attributed to John and reattributed to Samantha).

27 Stop Double Counting Joe and Mary are married. Joe owns 100 shares of Joeco, Inc. Joe and Mary are also 50% partners in Maryco, LP. Under the attribution rules, Mary is deemed to own 100 shares of Joeco, Inc. Thus, under the attribution rules, it would seem that Maryco would own 200 shares of Joeco. However, Reg (b)(2) prevents Joe s ownership from being attributed to Mary (under the family attribution rules) and then to Maryco. Thus, Maryco is only deemed to own 100 shares of Joeco. Limit on Family Reattribution Returning to the first example, the result is the same as the stock was attributed to John through entity attribution and thus can be reattributed under family attribution. Assume the same facts except that in addition Jane, John s child and Samantha s stepchild owns another 15 shares of Jobco. John is deemed to own 105 shares (60 through Buzzco, 30 through Samantha and 15 through Jane) Samantha still owns 90 before and 60 after. The shares of Jane are attributed to John but since they are attributed under family attribution they are not reattributed under family attribution to Samantha.

28 Limit on Sideways Attribution Carl owns 1,000 shares of Napco, Inc. and is the beneficiary of a trust. The, trust in turn, is a beneficiary of Carol s estate. Under the entity attribution rules, both the trust and estate will be deemed to own 1,000 shares of Napco. However, Sylvia, an unrelated beneficiary of the trust will not be attributed any Napco ownership. Summary of Owner/ Attribution Rules a. All shares of stock owned by an owner (subject to the 50% corporate ownership rule) are deemed owned by the entity. b. Stock owned by an entity is deemed owned proportionately by the owners (subject to the 50% corporate ownership rule) for the following: (1) All shares actually owned by the entity (2) All shares the entity constructively owns under the option rule (3) All shares owned by the entity because it is the member of some other entity.

29 302(b)(2) Tests 1. Immediately after the redemption the shareholder must own less than 50% of the total combined voting power of all classes entitled to vote, and 2. Immediately after the redemption the shareholder must own less than 80% of the shareholder's prior ownership of voting and common stock of the corporation Example 302(b)(2) Acme has only one class of stock shares are issued and outstanding. Bob owns 400 shares and Jane owns 600 shares. If the corporation redeems 100 shares of Bob's stock, the redemption fails and the distribution is treated as a dividend. Bob's ownership before the buy-back was 40% i.e. 400/1000. Bob's ownership is less than 50% after the buy-back i.e. 300/900, but fails the less than 80% test. The target number is 80% X 40% = 32%. Bob's ownership percentage after the buy-back is 33.3%. Therefore the distribution is a dividend and not a redemption. If the corporation buys back 120 shares then the buy-back would qualify as a redemption. As before the less than 50% test is met. The less than 80% test is also met since the qualifying percentage is 32% and Bob's ownership is now 31.82%. Thus this buy-back constitutes a good redemption.

30 Example 302(b)(2) If the corporation redeems 100 shares from Bob and 200 from Jane, neither purchase is a good redemption. Jane's interest does not fall below 50% (i.e., 400/700) and Bob's increases to 43%, (300/700). The transaction is a dividend to both individuals. Partial Liquidation Requirements 1. To a shareholder that is not a corporation 2. Not essentially equivalent to a dividend, and 3. Attributable to the termination of a qualified business

31 Qualified Business A qualified business is one that: 1. Is not merely an investment 2. The corporation actively engaged in for a period of 5 years before the distribution, and 3. The business was not acquired in a taxable transaction during that 5 year period Liquidation - Shareholder Module 4

32 Stock Purchased at Different Times Susan Smith owns 20 shares of Power Corporation, a domestic corporation, 10 of which were acquired in 2000 at a cost of $1,500, and the remainder of 10 shares in December 2005, at a cost of $2,900. In April 2002, Susan received a distribution of $250 per share in complete liquidation. Total Amount Realized $5,000. Amount allocated to the 2000 shares = 10 X 250 = 2500 Amount allocated to the 2005 shares = 10 X 250 = 2500 Shares Acquired in 2000 Shares Acquired in 2005 Amount realized $2,500 $2,500 Adjusted basis $1,500 $2,900 Gain/loss realized/recognized $1,000 LTCG ($ 400) STCG Installment Obligations Susan Luzez purchases 50 shares of Petco stock for $50,000 in 2002 and an additional 25 shares of Petco on December 31, 2004 for $10,000. Susan receives her first installment payout on July 1, 2009, of $30,000, her second payment on July 1, 2010 of 60,000, and her third payment on July 1, 2011, of $6, Stock Purchase 50 Shares 2004 Stock Purchase 25 Shares 2009 Payment $ 20,000 $ 10,000 Basis $ 50,000 $ 10,000 Gain/Loss Realized ($ 30,000) Payment $ 40,000 $ 20,000 Remaining Basis $ 30,000 0 Gain/loss Realized $ 10,000 $ 20,000 Gain/loss Recognized $ 10,000 $ 20, Payment $ 4,000 $ 2,000 Remaining Basis 0 0 Gain/Loss Realized $ 4,000 $ 2,000 Gain/Loss Recognized $ 4,000 $ 2,000

33 Liability Example Shareholder Mary Olthyme receives a liquidating distribution of a building worth $1,000,000 subject to a mortgage of $800,000 which Mary agrees to pay. Mary's basis in her shares is $50,000. Mary's gain will be computed as follows: Amount Realized $1,000,000 Mortgage ($ 800,000) Amount Realized Reduced by The Assumed Mortgage $ 200,000 Basis in Shares $ 50,000 Gain Recognized $ 150, Distribute Installment Obligation 1. Must have been acquired in connection with the sale or exchange of property by the distributing corporation which took place during the twelve month period beginning on the date the plan of liquidation was adopted, and 2. The liquidation must have taken place during the above twelve month period 3. Installment obligations arising from the sale of inventory do not qualify unless: a. The sale is to one person and b. The sale is a bulk sale of inventory

34 Liquidation - Corporation Module 5 Assumption of Liability Essex Corporation makes a liquidating distribution of two properties: A property and B property. The tax characteristics of both properties are as follows: Property A Property B Fair Market Value $10,000 $10,000 Basis $ 5,000 $ 5,000 Liability $15,000 $ 4,000 Essex Corporation will recognize the following gains if it distributes these properties under IRC Secs. 336(a) and 336(b): Property A Property B Deemed Sales Price $15,000 $10,000 Basis $ 5,000 $ 5,000 Gain Realized $10,000 $ 5,000

35 Loss Property to Majority Shareholder Mary and Stephen own 60% and 40% of Simpson Corporation stock, respectively. Simpson makes a liquidating distribution of its assets, which consist of the following properties: Basis Fair Market Value Cash $ 500,000 $ 500,000 Real Estate $2,000,000 $ 500,000 Inventory $ 600,000 $1,000,000 Mary received all of the real estate and $700,000 worth of inventory. Stephen received all the cash and $300,000 worth of inventory. The corporation must recognize $400,000 of gain on the distribution of the appreciated inventory but cannot recognize any of the loss on the distribution of the real estate. The related party did not receive her share of each type of property. Thus the distribution was not pro-rata with respect to the related party. ASSUME: The loss property was not acquired by the corporation during the five year period prior to the distribution in either a nontaxable transfer under IRC Sec. 35l or a contribution to capital. Shift Property to Minority Assume the same facts as above except that Mary received all the inventory and $200,000 in cash and Stephen received the real estate and $300,000 in cash. In this case the corporation would recognize both the gain on the inventory as well as the loss on the real estate. The loss property was not distributed to a related party, but rather to an unrelated party and hence the 336(d)(1) restriction does not apply.

36 Anti-Stuffing Example McClary Corporation is a closely held corporation where each of ten shareholders, unrelated parties, owns 10% of the stock of the corporation. On September 1, 2009, shareholder Bob Taft contributed Blackacre to McClary Corporation. Blackacre had a basis of $250,000 and a fair market value of $100,000. Bob was aware that McClary was not doing well and might have to be liquidated. On October 15, 2010, McClary adopts a plan to liquidate the corporation. At the time of the adoption of the plan of liquidation and at all times through the final liquidating distribution McClary had the following assets, which it distributed in liquidation: Fair Market Value Basis Cash $ 10,000 $ 10,000 Whiteacre $500,000 $250,000 Blackacre $ 50,000 $250,000 McClary must recognize the gain on Whiteacre of $250,000. With regard to Blackacre the basis is reduced to $100,000. Accordingly for purposes of computing the loss the calculation would be as follows: Fair Market Value $ 50,000 Basis: Original Basis $250,000 Pre-contribution Built in Loss $150,000 IRC 336(d)(2) Basis Sec. $100,000 Loss Recognized On Liquidation $ 50,000 Liquidation of a Subsidiary Module 6

37 Example 332 Liquidation A-One Corporation had outstanding capital stock of 3,000 shares of common stock, par value $100 a share, and 1,000 shares of preferred stock, par value $100 a share. The preferred stock is limited and preferred as to dividends and has no voting rights. At all times B-Fair Corporation owned 2,500 shares of common stock of A-One. By statutory merger consummated on October 1, 2009, pursuant to a plan of liquidation adopted on June 1, 2009, A-One Corporation was merged into B-Fair Corporation. B-Fair Corporation issued shares that were distributed to the holders of A-One stock in return for their A-One shares. B-Fair Corporation took over all the properties of A-One Corporation. The above transaction is a complete liquidation of A-One Corporation within the meaning of IRC Sec The result is that no gain or loss is recognized as a result of the receipt by B-Fair of A-One's properties. Distribution to Minority Shareholder Parent Corporation owns 80% of Subsidiary Corporation. John Adams, an individual, owns the remaining 20% of Subsidiary Corporation. Subsidiary Corporation is undergoing a IRC Sec. 332 liquidation. Subsidiary has the following assets: Fair Market Value Basis Equipment $1,000,000 $ 100,000 Real Estate $4,000,000 $1,000,000 Subsidiary Corporation distributes the equipment to John Adams and the real estate to Parent Corporation. Since the liquidation qualifies under IRC Sec. 332 neither Subsidiary nor Parent will recognize any gain on the transfer of the property to Parent. IRC Sec. 332 does not apply to the distribution to the minority shareholder, however, and so Subsidiary will recognize a $900,000 gain on the distribution of equipment to Adams.

38 Loss Property to Minority Shareholder Parent Corporation owns 80% of Subsidiary Corporation. John Adams, an individual, owns the remaining 20% of Subsidiary Corporation. Subsidiary Corporation is undergoing a IRC Sec. 332 liquidation. Subsidiary has the following assets. Fair Market Value Basis Equipment $1,000,000 $2,000,000 Real Estate $4,000,000 $1,000,000 Subsidiary Corporation distributes the equipment to John Adams and the real estate to Parent Corporation. Since the liquidation qualifies under IRC Sec. 332 neither Subsidiary nor Parent will recognize gain on the transfer of the real estate to Parent. Subsidiary cannot recognize any loss on the distribution of the depreciated property to the minority shareholder under IRC Sec. 336(d)(3). Hence no loss will be recognized on the distribution of the equipment to Adams. Section 338 Election Module 7

39 Cost of 338 Election Maxim Corporation purchases 100% of the common stock of Minimum Corporation for $1 million. Minimum has only one asset, land, with a basis of $600,000 and a fair market value of $1 million. Assuming that Minimum makes an IRC Sec. 338 election, Minimum must recognize a $400,000 gain on the deemed sale of the land. The net tax effect of the IRC Sec. 338 election, assuming an effective tax rate of 34% is 34% x $400,000 = $136,000. Presumably then an IRC Sec. 338 election would not be worthwhile unless the present value of the future benefits of the election were greater than $136,000. If the only asset of the corporation is land, and there is no intention to sell the land immediately, it is hard to see what advantage such an election might be to the electing corporation. Even assuming the property is depreciable, it is difficult to see how the present value of the future depreciation deductions could be greater than $136,000. Aggregate Deemed Sales Price If, during the acquisition period, Purchaser acquires 80 % of the target s stock for $800,000. The grossed up amount realized will be $1,000,000 (800,000/. 80).

40 Aggregate Deemed Sales Price On November 1, 2009 Smaller Corp. s stock has a value of $1,250,000. On that date, Bigger Corp. makes the following purchases of Smaller Corp. s outstanding common stock: 40% from Joe for $500,000 20% from Sheila for $225,000 20% from Cory for $275,000 Jason continues to hold the remaining 20% of outstanding common stock. The combined selling costs of the three shareholders are $10,000. The grossed-up amount realized on the sale to Bigger Corp. of Bigger s recently purchased Smaller stock is calculated as follows: The total amount realized (without regard to selling costs) is $1,000,000 ($500,000 + $225,000 + $275,000). The percentage of Smaller s stock by value on the acquisition date attributable to the recently purchased T stock is 80% ($1,000,000/($1,250,000)). Thus the grossed up amount is $1,240,000 (($1,000,000/.8)! $10,000). Class I: Class II: Class III Class IV: Class V: Class VI: Class VII: Cash and cash equivalents; Certificates of deposit, foreign currency, marketable securities and actively traded personal property as defined in?1092(d) (dealing with hybrid straddle type instruments); Accounts receivable, mortgages and credit card receivables that arise in the ordinary course of business; Stock in trade or other property the kind that would included in inventory if on hand at the end of the year, or property held by the taxpayer primarily for sale to customers in the ordinary course of business; Assets not in Class I, II, III or IV; All IRC Sec. 197 Intangible assets except good will and going concern value (for example work force in place, information bases, patents, copyrights, licenses, and covenants not to compete); and Goodwill and Going Concern Value

41 Example Terrific Corporation owns 90% of the only class of outstanding stock of Titanic Corporation. Purchaser Corporation acquires 100% of the only class of outstanding stock of Terrific for $2,000,000 and makes an IRC Sec. 338 election on behalf of Terrific. Terrific Corporation has nonrecourse mortgage plus unsecured liabilities of $700,000 and taxes payable, including tax on the deemed sale under IRC Sec. 338, of $300,000. Terrific's AGUB is determined as follows: Grossed Up Basis $2,000,000 Total Liabilities $1,000,000 AGUB $3,000,000 Example Cash I $ 200,000 Certificates of deposit II $ 300,000 Inventory IV $ 300,000 Accounts Receivable III $ 600,000 Building V $ 800,000 Land V $ 200,000 Investment in Titanic V $ 450,000 TOTAL $2,850,000

42 Example 338(h)(10) Sale Wholesome Corporation is a member of an affiliated group with Acme as the parent. The Acme group is on the calendar year and files a consolidated tax return. Wholesome's assets have a fair market value of $1,000,000 and a basis to Wholesome of $400,000. Wholesome has no liabilities. Disaster Corporation acquires 100% of Wholesome's stock on June 1, 2008 for $1,000,000. Acme had a basis of $500,000 in its Wholesome stock. Wholesome makes an IRC Sec. 338 election and an IRC Sec. 338(h)(10) election. Wholesome will be deemed to have sold all of its assets for their fair market value of $1,000,000 and will thus recognize a gain of $600,000, all of which will be recognized. This gain will be reported on the final consolidated tax return Wholesome files with the Acme group. Acme does not recognize any gain on the sale of its Wholesome stock to Disaster. Disaster's basis in its Wholesome stock will be $1,000,000. Acme succeeds to the tax attributes of Wholesome as in a regular IRC Sec. 332 liquidation. 336(e) Sale Whole Corporation is a member of a consolidated group with Acme Corporation as the parent. Acme owns 100% of the stock of Whole Corporation and sells all of its stock to Ross Stockdale, an individual, for $1,000,000. Acme had a basis of $500,000 in its stock. Whole Corporation's basis in its assets is $500,000 and the fair market value of the assets is $1,000,000. Whole Corporation had no liabilities. Assuming that Acme elects to be covered under the provisions of IRC Sec. 336(e) Acme will be deemed to have liquidated Whole under IRC Sec. 332 and then subsequently sold the subsidiary's assets to Ross Stockdale, rather than sold him the stock. The result is that Acme will be taxed on the gain of $500,000, the gain on the deemed sale under IRC Sec. 336(e), rather than on the sale of the stock, which is ignored. Whole Corporation's basis in its properties is stepped up to $1,000,000.

43 Corporate Reorganizations Module 8 Control Example Bob Belhed owns 83% of Xenon Corporation s Class A voting common stock, 83% of Xenon's Class non-voting common stock and 22% of Xenon's Class A non-voting preferred stock. The class B non-voting stock has 5,000 shares outstanding and the Class A non voting stock has 100 shares outstanding. Belhed owns more than 80% of the total number of shares of Xenon's non voting shares. Since Belhed owns less than 80% of Xenon's Class A non-voting preferred stock, Belhed does not control Xenon because he does not own 80% or more of each class of non-voting stock. Thus the requirement is that control requires ownership of at least 80% of each class of non-voting stock, but not each class of voting stock.

44 Special D Control Rule Father and Son each own 40% of the non voting preferred stock of McClary Corporation. Father and Son own no other stock in McClary. Together their stock represents 60% of the total fair market value of all McClary's outstanding stock. In the case of a non-divisive reorganization, both Father and Son control McClary because father is treated as owning Son's stock and vice versa. This rule would not apply to any other type of reorganization... only an acquisitive D. Continuity - Unrelated Sale Assume that John owns 100 percent of the stock of ABCco. (value -- $100) and XYZco plans to merge into ABCco.. Shortly before the merger, Jane, who is unrelated to XYZco or to ABCco, purchases all of John s ABCco stock for cash, and then Jane exchanges her ABCco stock for $50 of XYZco stock and $50 of cash furnished by XYZco. Under the regulations, the sale is disregarded and the continuity of interest requirement is met under the 50% brightline test.

45 Attachments to Return of Party to Reorganization a. A statement entitled STATEMENT PURSUANT TO REG (a) BY [INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A CORPORATION A PARTY TO A REORGANIZATION; b. The names and employer identification numbers (if any) of all such parties; c. The date of the reorganization; d. The aggregate FMV and basis, determined immediately before the exchange, of the assets, stock or securities of the target corporation transferred in the transaction; and e. The date and control number of any private letter ruling(s) issued by the Internal Revenue Service in connection with this reorganization. Significant Holder a. A statement entitled STATEMENT PURSUANT TO REG (b) BY [INSERT NAME AND TAXPAYER IDENTIFICATION NUMBER (IF ANY) OF TAXPAYER], A SIGNIFICANT HOLDER, b. The names and employer identification numbers (if any) of all of the parties to the reorganization; c. The date of the reorganization; and d. The fair market value, determined immediately before the exchange, of all the stock or securities of the target corporation held by the significant holder that is transferred in the transaction and such holder's basis, determined immediately before the exchange, in the stock or securities of such target corporation.

46 Debt in C Reorg Example The Growth Corporation acquires the Slowdown Corporation s assets of $1,000,000 for $790,000 in Growth Corporation voting stock and the assumption of $210,000 of Slowdown s debt. This meets the solely-for-stock requirement of a C corporation since the liabilities here are disregarded as boot. Debt in C Reorg Example Assume the same facts as in the first example, except that Growth assumes $200,000 in debt and pays $10,000 cash boot. Now, the payment of $10,000 of cash boot requires Slowdown to include the $200,000 debt assumption as boot. Since this exceeds 20% ($1,000,000 X 20% = $200,000) of the consideration paid, this won t qualify as a non-taxable C reorganization.

47 D Safe Harbor Safe Harbor I The acquisition occurs more than six months after the distribution; there was no agreement, understanding, arrangement, or substantial negotiations concerning the acquisition or a similar acquisition during the one year period before and the six month period after the distribution; and the distribution was motivated in whole or substantial part by a corporate business purpose. D Safe Harbor Safe Harbor II - The acquisition occurs more than six months after the distribution; there was no agreement, understanding, arrangement, or substantial negotiations concerning the acquisition or a similar acquisition during the during the one year period before and the six month period after the distribution; the distribution was not motivated to facilitate the acquisition or a similar acquisition; and no more that 25% of the stock of the acquired corporation was acquired (or the subject of an agreement, etc.) during the one year/six month period.

48 D Safe Harbor Safe Harbor III - An acquisition occurs after a distribution; there was no agreement, understanding, or arrangement concerning the acquisition or a similar acquisition at the time of the distribution; and there was no agreement, understanding, arrangement, or substantial negotiations concerning the acquisition or a similar acquisition within one year after the distribution. D Safe Harbor Safe Harbor IV - A nonpublic offering acquisition occurs before the date of the first disclosure event regarding the distribution, unless the acquiring corporation is a controlling or 10% shareholder of the acquired corporation at any time between the acquisition and the distribution, or the acquisition occurs in connection with a transaction in which the aggregate acquisitions are of stock possessing 20% or more of the total voting power or 20% or more of the total value of the acquired corporation.