Mastering Corporate Tax

Transcription

1 Mastering Corporate Tax Reginald Mombrun NORTH CAROLINA CENTRAL UNIVERSITY SCHOOL OF LAW Gail Levin Richmond NOVA SOUTHEASTERN UNIVERSITY LAW CENTER Felicia Branch NORTH CAROLINA CENTRAL UNIVERSITY SCHOOL OF LAW CAROLINA ACADEMIC PRESS Durham, North Carolina

2 Contents List of Figures Table of Cases Table of Revenue Rulings Table of Revenue Procedures Series Editor's Foreword Preface Acknowledgments xxv xxvii xxix xxxi xxxiii xxxv xxxvii Part One: Introduction Chapter 1 Sources of Tax Law 3 Roadmap 3 A. Introduction 3 B. Legislative Sources 3 1. Internal Revenue Code 3 a. Overview 3 b. Structure 4 c. Dates 4 2. Legislative History 4 3. Treaties 5 C. Administrative Sources 5 1. Treasury Regulations 5 a. Overview 5 b. Numbering System 6 c. Preambles 6 2. IRS Documents 7 a. Letter Rulings and Revenue Rulings 7 b. Other IRS Documents 7

3 D. Judicial Sources ' 8 E. Examples of Sources of Law 8 Checkpoints 9 Chapter 2 Corporate Tax Policy and Doctrines 11 Roadmap 11 A. Policy 11 B. Doctrines Substance over Form Business Purpose Step Transaction Economic Substance/Sham Transaction 13 Checkpoints 14 Chapter 3 An Overview of C Corporation Taxation 15 Roadmap 15 A. Forms of Doing Business Characteristics of a Business Entity Determining Which Tax Regime Applies 16 a. Incorporated Entities 16 b. Unincorporated Entities: Check-the-Box Regulations Who Is Taxed on an Entity's Income? 17 B. Avoiding Double Tax on Corporate Earnings 18 C. Subchapter C and Corporate Taxation 18 D. Taxation of Corporation's Operations: Overview 19 E. Gross Income General Rule Contributions to Capital 20 F. Deductions Deductions Available to Individuals and Corporations Deductions Available Only to Individuals Deductions Available Only to Corporations 23 a. Organizational Expenditures 23 b. Dividends Received and Premium on Repurchasing Debt Nondeductible Items 25 a. In General 25 b. Limitations Applied to Corporations 26 c. Sales Between Related Parties 26 G. Accounting Methods In General ' Related Taxpayers 27

4 3. At-Risk and Passive Activity Limitations 28 H. Taxable Year 29 I. Capital Gains and Losses Tax Rate Applied to Net Capital Gains Limitations on Deducting Net Capital Losses Sales Between Related Parties Other Capital Gain and Loss Limitations 32 J. Corporate Tax Rates 32 K. Credits 33 L. Other Corporate Taxes Alternative Minimum Tax Accumulated Earnings and Personal Holding Company Taxes 34 a. Accumulated Earnings Tax 35 b. Personal Holding Company Tax 36 Checkpoints 38 Part Two: Formation of C Corporations Chapter 4 Incorporation of a Business Section Roadmap 41 A. Introduction Benefits of Corporate Form of Doing Business Policy Reasons for Nonrecognition and Importance of Section B. The General Rule of Section C. The Meaning of Property 44 D. What Constitutes a Transfer? 45 E. To Whom Must the Property Be Transferred? 46 F. Receipt of Stock 47 G. Transferor(s) Must Have Control of Corporation Description of Control Transferor(s) Must Have Control Immediately after the Transfer A Brief Discussion of the Step Transaction Doctrine Nonsimultaneous Transfers 51 H. Tax Consequences to Transferor(s) General Rule Tax Planning Opportunity? Assumption of Liabilities 53 a. General Rule 53 b. Exceptions to the General Rule 54

5 4. Basis Consequences 5. Allocating Basis to Stock Received 6. Assumption of Liabilities 7. Holding Period I. Tax Consequences to Transferee Corporation 1. No Gain or Loss 2. Basis of Property a. General Rule b. Loss Limitation under Section 362(e) 3. Holding Period of Property Received J. Transfers to an Investment Company K. Overlap with Other Code Sections L. Miscellaneous Procedural Matters Checkpoints Chapter 5 Corporation's Capital Structure Roadmap A. Types of Capital B. Nontax Characteristics of Debt and Equity: An Overview 1. Debt 2. Equity C. Tax Characteristics of Debt and Equity 1. Debt a. Corporate Debtor b. Creditor 2. Equity a. Corporate Issuer b. Shareholder D. Hybrid Instruments E. Section Factors 2. Classification by the Issuer Checkpoints Part Three: Corporate Distributions Chapter 6 Dividend Distributions Roadmap A. Distributions Covered by Section Distributions of Property

6 2. To a Shareholder With Respect to the Shareholder's Stock 78 B. Amount Distributed 79 C. Dividend 80 D. Corporation's Tax Consequences Taxable Amount Effect on E&P 81 E. Shareholder's Tax Consequences Income Tax 82 a. Gross Income 82 b. Dividends Received Deduction 83 c. Tax Rate Basis and Holding Period of Property Received Basis of Shareholder's Stock 84 F. Nontaxable Distributions of Stock or Rights Exclusion from Shareholder's Gross Income Basis and Holding Period of Stock and Stock Rights 86 a. General Rule 86 b. Rights to Acquire Stock Effect on Issuing Corporation 88 G. Taxable Distributions of Stock or Rights Distributions Covered by Section 305 (b) 88 a. Distributions in Lieu of Money 88 b. Disproportionate Distributions 88 c. Distributions of Common and Preferred Stock 90 d. Distributions on Preferred Stock 91 e. Distributions of Convertible Preferred Stock 91 f. Transactions Treated as Distributions Tax Consequences of Taxable Stock Distributions 93 H. E&P Items Affecting E&P 93 a. Accounting Methods and Timing 94 b. Income 95 c. Deductions Current and Accumulated E&P Allocating E&P to Distributions 96 a. Current E&P 96 b. Accumulated E&P 97 Checkpoints 100

7 Chapter 7 Redemption Distributions 103 Roadmap 103 A. Overview 104 B. Constructive Ownership Family Attribution 105 a. Multiple Attributions 106 b. Family Hostility Attribution from an Entity 107 a. Entities 107 b. Multiple Attributions Attribution to an Entity 109 a. Entities 109 b. Multiple Attributions Option Attribution 110 C. Section 302 Redemptions Substantially Disproportionate Redemption 111 a. Ownership Percentage after the Redemption 111 b. Reduction in Voting Stock Percentage 112 c. Reduction in Common Stock Percentage 112 d. Multiple Redemptions 113 e. Effect of Constructive Ownership Complete Termination of the Shareholder's Interest 114 a. Constructive Ownership 114 b. Waiving Family Attribution by Family Members 115 c. Waiving Family Attribution by Entities Partial Liquidation, 117 a. Qualifying Shareholders 117 b. Qualifying Redemptions 118 c. Pro Rata Redemptions Redemption That Is Not Essentially Equivalent to a Dividend Redemption That Qualifies under More Than One Provision 121 D. Section 303 Redemptions Limitation on Qualifying Amount Requirements to Qualify 122 a. Inclusion in Gross Estate 122 b. Required Stock Value 123 c. Required Burden on Shareholder's Interest in Estate 124 d. Time Periods for Redemption 124 E. Section 304 Redemptions 124

8 1. Related Corporations 125 a. Brother-Sister Corporations 125 b. Parent-Subsidiary Corporations Reconstructing a Section 304 Transaction 126 a. Testing for Qualification as a Redemption 126 b. Consequences of Failure to Qualify as a Redemption Interplay of Sections 304 and F. Section 306 Dispositions Definition of Section 306 Stock 130 a. Stock That Is Section 306 Stock 130 b. Stock That Is Not Section 306 Stock Dispositions of Section 306 Stock 131 a. General Rules 131 b. Exceptions 132 G. Tax Consequences of Redemption: Corporation Taxable Income E&P 133 a. Redemption Treated as a Dividend 133 b. Redemption Treated as an Exchange 133 c. Certain Dispositions of Section 306 Stock Basis of Stock Acquired in a Section 304 Transaction 134 H. Tax Consequences of Redemption: Shareholder Redemption Treated as a Distribution 135 a. Taxable Income 135 b. Basis and Holding Period of Property Received 135 c. Basis of Stock Retained Redemption Treated as an Exchange 136 a. Taxable Income 136 b. Basis and Holding Period Section 304 Redemptions 136 I. Transfers of Control Marital Dissolution 137 a. Background 137 b. Treasury Regulations Other Transfers of Control 139 Checkpoints 139

9 Part Four: Tax-Free Restructurings (Reorganizations) Chapter 8 Acquisitive Reorganizations 143 Roadmap 143 A. Introduction 143 B. Transactions That Qualify as Reorganizations 144 C. General Reorganization Requirements Business Purpose Continuity of Interest Continuity of Business Enterprise Step Transaction Doctrine 147 D. Technical Requirements of the A Reorganization Introduction The Disregarded Entity Merger 151 a. In General 151 b. Liabilities of Disregarded Entities The Triangular A Reorganizations 153 a. The Forward Triangular Merger 153 b. The Reverse Triangular Merger Review of the A Reorganization 154 E. Technical Requirements of the B Reorganization Introduction Creeping B Reorganizations Boot Concerns Review of the B Reorganization 157 F. Technical Requirements of me C Reorganization Introduction The Solely for Voting Stock Requirement The Liquidation Requirement The Substantially All Requirement Creeping C Reorganizations Final Concerns Review of the C Reorganization 161 G. Technical Requirements of the Acquisitive D Reorganization Introduction Transfer of Assets The Control Requirement The Distribution Requirement Review of the Acquisitive D Reorganization 164 H. The G Reorganization 164

10 I. Asset Drop-Downs Following an Acquisitive Reorganization 165 J. Push-Ups of Assets 166 K. Reorganizations Involving Investment Companies 166 L. Exchange and Receipt of Net Value 167 M. Tax Consequences to Shareholders In General Party to a Reorganization Gain or Loss to Acquiring Shareholders Gain or Loss to Target Shareholders Nonqualified Preferred Stock Transactions Involving Railroads Warrants Treatment of Boot Basis Consequences to Target Shareholders 172 a. In General 172 b. Basis in Triangular Reorganizations Assumption of Liabilities Holding Period of Acquiring Stock in the Hands of Target Shareholders 174 N. Tax Consequences to the Acquiring Corporation Introduction Gain or Loss to the Acquiring Corporation Basis Consequences to the Acquiring Corporation Holding Period Carryover of Tax Attributes, 176 O. Tax Consequences to the Target Corporation Gain or Loss ' Basis and Holding Period of Property Received 177 Checkpoints 177 Chapter 9 Nonacquisitive, Nondivisive Reorganizations (Recapitalizations, F Reorganizations) 179 Roadmap 179 A. Introduction 179 B. What Is a Recapitalization? 180 C. Boot Recognition and Loss Limitation 181 D. COI and COBE in Recapitalizations 182 E. Technical Requirements of the F Reorganization Introduction Change of Tax Status 184

11 xvi CONTENTS 3. Identification of Shareholders Advantages of the F Reorganization 184 F. Tax Consequences of Qualifying as an E or F Reorganization Shareholders Recognize No Gain or Loss Basis of Stock or Securities Received in an E or F Reorganization Holding Period 187 Checkpoints 187 Chapter 10 Divisive Reorganizations Section Roadmap 189 A. Introduction Overview Types of Section 355 Transactions 190 B. Basic Requirements Distribution of Stock or Securities Distribution of Stock of Controlled Corporation 193 a. In General 193 b. Control Immediately Before the Distribution 194 c. Impact of Warrants and Options The Anti-Device Requirement 195 a. Device Factors 195 b. Nondevice Factors 198 c. Transactions Not Ordinarily Considered Devices The Active Trade or Business Requirement 200 a. In General 200 b. Definition of Trade or Business 200 c. What Constitutes "Active"? 200 d. Ownership of Real Property 202 e. Activities of Independent Contractors 202 f. Employees of Related Entities 202 g. Active Trade or Business in a Partnership 203 h. Attribution of Active Trade or Business from a Corporation 203 i. The Five-Year Requirement 204 j. Expansion of a Business The Continuity of Interest Requirement The Business. Purpose Requirement 206 a. Criteria for Business Purpose 206 b. Deciphering the Business Purpose 207 C. Certain Transactions That Will Not Qualify under Section

12 xvii 1. In General Section 355(d) In General Section 355(e) Section 355(f) Section 355(g) 215 D. Tax Consequences to Distributing Corporation Gain or Loss Liabilities Transfer General Rule 216 a. Avoidance of Federal Income Tax 216 b. Liabilities in Excess of Basis Gain or Loss in D/3 55 Transactions 217 E. Tax Consequences to Shareholders Gain or Loss 218 a. Section 355(a) 218 b. Receipt of Securities 220 c. Receipt of Property Attributable to Accrued Interest 220 d. Characterization of Boot Received Basis of Stock or Securities 221 a. Basis of Stock 221 b. Basis of Securities and Other Boot Received Holding Period 222 F. Distributing Corporation's Tax Attributes 222 G. Tax Consequences to Controlled Corporation In General Recognition of Gain or Loss, Basis of Controlled Corporation's Assets Transfer of Tax Attributes 223 H. Tax Consequences of Taxable Spin-off Recognition of Gain or Loss Basis of Stock Transfer of Tax Attributes 225 I. Conclusion 225 Checkpoints 227 Chapter 11 Termination of the Corporation (Corporate Liquidation) 229 Roadmap. 229 A. Introduction 229 B. Liquidations of Corporations Other Than Subsidiaries Liquidating Corporation's Tax Consequences 230 a. Gain or Loss on Distribution 230

13 b. Liabilities 230 c. Loss Limitations 231 d. E&P Account Recipient Shareholder's Tax Consequences 234 a. Gains and Losses 234 b. Basis for Property Received 234 c. Holding Period for Property Received 234 C. Liquidations of Corporate Subsidiaries Introduction 235 a. Control Requirement 235 b. Timing 236 c. Plan of Liquidation Liquidating Corporation's Tax Consequences 237 a. General Rule 237 b. Distributions to Minority Shareholders 237 c. E&P Account and Other Tax Attributes Corporate Parent's Tax Consequences 238 a. Gains and Losses 238 b. Basis for Property Received 239 c. Holding Period for Property Received 240 d. E&P and Other Attributes 240 Checkpoints 241 Chapter 12 Carryover of Tax Attributes 243 Roadmap, 243 A. Introduction 243 B. Section 381 ' Scope of the Section Acquisitions Covered Acquiring Corporation Attributes 245 C. Section 381(b) Operating Rules End of Taxable Year Date of Distribution or Transfer NOL and Capital Loss Carryovers 247 D. Tax Attributes Governed by Section Overview NOL Carryovers Capital Loss Carryovers E&P Carryovers 249

14 xix 5. Accounting Methods 249 E. Section Comparison to Section Section 382 Loss Limitation Section 382 Definitions 250 a. Loss Corporation 250 b. Ownership Change Operation of Section Changes Made by the American Recovery and Reinvestment Act of F. Section G. Section Checkpoints. 254 Part Five: Taxable Acquisitions Chapter 13 Certain Taxable Transactions 257 Roadmap 257 A. Introduction Significance of Section Origins of Section B. Section 338 Terminology 260 C. Qualifying for Section In General Making the Section 338(g) Election 261 D. Effect of Section 338 Election 261 E. Target Corporation's Tax Consequences Gain or Loss on Deemed Sale 262 a. 100 Percent of Target's Stock Acquired 262 b. Less Than 100 Percent of Target's Stock Acquired Basis for Assets Deemed Purchased 264 a. Basis Attributable to Stock 264 b. Election for Nonrecently Purchased Stock 265 c. RedeterminationofADSPandAGUP Allocation Rules Holding Period 266 E Asset and Stock Consistency Rules 266 G. Section 338(h)(10) Election In General Step Transaction Issues 268

15 H. Section Introduction Applicable Asset Acquisition Asset Allocation Rules 269 Checkpoints 270 Part Six: Corporations That Share the Same Owners Chapter 14 Controlled Corporations and Affiliated Corporations 273 Roadmap 273 A. Introduction 273 B. Controlled Corporations In General Parent-Subsidiary Controlled Group Brother-Sister Controlled Group Combined Group Insurance Group 276 C. Restrictions Applied to a Controlled Group 277 D. Affiliated Groups In General Definition of Affiliated Group The 80 Percent Test Reconsolidation Following Disaffiliation Definition of Stock 280 a. Statutory Definition 280 b. Regulations 280 c. Good Faith Affiliation and Disaffiliation Ineligible Corporations 282 a. General Rule 282 b. Exceptions 282 Checkpoints 284 Chapter 15 Consolidated Returns 285 Roadmap 285 A. Introduction 285 B. Consolidated Return Issues In General Deciding to File Consolidated Returns 286 C. Consent to File Consolidated Returns 287 D. Difficulty in Deconsolidating 287

16 E. Group Remaining in Existence F. Computation of Income and Liability for Tax G. Intercompany Transaction Rules 1. In General 2. What Is an Intercompany Transaction? 3. Matching and Acceleration Rules H. The Basis Investment Adjustment Rules 1. Introduction 2. Adjustments to Basis I. Loss Disallowance Regulations Checkpoints Part Seven: S Corporations Chapter 16 Taxation of S Corporations and Their Shareholders Roadmap A. Introduction B. Eligibility Requirements 1. Domestic Corporation 2. Ineligible Corporation a. Insurance Companies b. Financial Institutions c. DISCs d. Corporations with Possession Tax Credit e. Taxable Mortgage Pools 3. Permissible Types of Shareholders a. Individuals b. Estates c. Trusts d. Other Eligible Organizations 4. Limit on Number of Shareholders 5. One Class of Stock Requirement a. Buy-Sell and Redemption Agreements b. Varying Interests c. Restricted Stock 6. Corporate Subsidiaries C. The S Election D. Corporate Effect of S Election 1. Introduction 2. Computation of Corporation's Taxable Income

17 xxii CONTENTS 3. Built-in Gain Tax Tax on Passive Investment Income 309 a. Accumulated Earnings and Profits 309 b. Gross Receipts Test 309 c. Computation of Tax 309 d. Coordination with Section E. Shareholder Effect of S Election Introduction Pass-Through Items 311 a. Separately Stated Items 311 b. Nonseparately Stated Items Allocation of Income and Loss 314 a. General Rule 314 b. Election to Close the Books 314 F. Limits on Losses 315 G. Basis in Stock and Debt Initial Stock and Debt Basis Adjustments to Debt Basis Outside of Subchapter S 315 a. Guarantee of Corporate Debt 315 b. Payments on a Guarantee Increases to Basis of Stock in S Corporation Decreases to Basis of Stock in S Corporation Decreases to Basis of S Corporation Debt Increases to Basis of S Corporation Debt 318 a. General Rule, 318 b. Multiple Indebtedness 318 c. Effect of Distributions 319 H. Ordering Rules 320 I. Distributions Accumulated Adjustments Account Tax Treatment of Distributions to Shareholders 321 a. Distributions with No E&P 321 b. Distributions with E&P Timing of Distributions Accelerating Dividends Noncash Distributions Post-Termination Distributions 324 J. Termination and Revocation Introduction 325

18 xxiii 2. Events Causing Termination a. Revocation b. Excess Passive Investment Income c. Ceasing to Be a Small Business Corporation 3. Inadvertent Terminations 4. Effect of Termination 5. Reelection K. Miscellaneous Provisions Checkpoints Mastering Corporate Tax Checklist About the Authors Index