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Exam 4: Corporations: Organization and Capital Structure

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Question 21

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Sean,a sole proprietor,is engaged in a service business and uses the cash basis of accounting.In the current year,Sean incorporates his business by forming Aqua Corporation.In exchange for all of its stock,Aqua receives: assets (basis of $400,000 and fair market value of $2 million),trade accounts payable of $110,000,and loan due to a bank of $390,000.The proceeds from the bank loan were used by Sean to provide operating funds for the business.Aqua Corporation assumes all of the liabilities transferred to it.

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Question 22

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In a § 351 transfer,a shareholder receives boot of $10,000 but ends up with a realized loss of $3,000.Only $7,000 of the boot will be taxed to the shareholder.

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Question 23

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What are the tax consequences if an individual investor incurs a loss on the following:

In order to encourage the development of an industrial park,a county donates land to Ecru Corporation.The donation does not result in gross income to Ecru.

Lucy transfers equipment (basis of $25,000 and fair market value of $120,000) to White Corporation.In return,Lucy receives 80% of White Corporation's stock (worth $70,000) and an automobile (fair market value of $15,000) .In addition,there is an outstanding mortgage of $35,000 (taken out 5 years ago) on the equipment,which White Corporation assumes.With respect to this transaction:

The receipt of nonqualified preferred stock in exchange for the transfer of appreciated property to a controlled corporation results in recognition of gain to the transferor.

Rachel owns 100% of the stock of Cardinal Corporation.In the current year Rachel transfers an installment obligation,tax basis of $180,000 and fair market value of $350,000,for additional stock in Cardinal worth $350,000.

In order to retain the services of Eve,a key employee in Ted's sole proprietorship,Ted contracts with Eve to make her a 30% owner.Ted incorporates the business receiving in return 100% of the stock.Three days later,Ted transfers 30% of the stock to Eve.Under these circumstances,§ 351 will not apply to the incorporation of Ted's business.

Stock in Merlin Corporation is held equally by Jane,Eve,and Fred.Merlin seeks additional capital to buy a valuable tract of land that will cost $6,000,000.Jane,Eve,and Fred propose to loan Merlin $2,000,000 each,taking from Merlin a $2,000,000 ten-year note with interest payable annually at five points above the prime rate.Merlin Corporation has current taxable income of $7,000,000.How are the payments on the notes treated for tax purposes?

One month after Sally incorporates her sole proprietorship,she gives 25% of the stock to her children.Section 351 cannot apply to Sally because she has not satisfied the 80% control requirement.

Issues relating to basis arise when a taxpayer is involved in a § 351 transaction.Describe the underlying rules,and the purpose they serve.

Tom and George form Swan Corporation with the following investments: Tom transfers machinery worth $100,000 (basis of $40,000) ,while George transfers land worth $90,000 (basis of $20,000) and services rendered in organizing the corporation worth $10,000.Each is issued 25 shares in Swan Corporation.With respect to the transfers:

Shawn transfers property (basis of $40,000 and fair market value of $35,000) to Condor Corporation in exchange for § 1244 stock.The transfer qualifies as a nontaxable exchange under § 351;therefore,Shawn's basis in the Condor stock is $40,000.Five years later,Shawn sells the Condor stock for $25,000.With respect to the sale,Shawn has:

Section 351 (which permits transfers to controlled corporations to be tax deferred)can be justified under the wherewithal to pay concept.

Kirby and Helen form Red Corporation.Kirby transfers property,basis of $20,000 and value of $300,000,for 100 shares in Red Corporation.Helen transfers property,basis of $40,000 and value of $280,000,and provides legal services in organizing the corporation.The value of her services is $20,000.In return Helen receives 100 shares in Red Corporation.With respect to the transfers:

Dick,a cash basis taxpayer,incorporates his sole proprietorship.He transfers the following items to newly created Orange Corporation. With respect to this transaction:

Tara incorporates her sole proprietorship,transferring it to newly formed Black Corporation.The assets transferred have an adjusted basis of $240,000 and a fair market value of $300,000.Also transferred was $10,000 in liabilities,$1,000 of which was personal and the balance of $9,000 being business related.In return for these transfers,Tara receives all of the stock in Black Corporation.

George transfers cash of $150,000 to Finch Corporation,a newly formed corporation,for 100% of the stock in Finch worth $80,000 and debt in the amount of $70,000,payable in equal annual installments of $7,000 plus interest at the rate of 9% per annum.In the first year of operation,Finch has net taxable income of $40,000.If Finch pays George interest of $6,300 and $7,000 principal payment on the note:

A shareholder transfers a capital asset to Red Corporation for its stock.If the transfer qualifies under § 351,Red's holding period for the asset begins on the day of the exchange.

Kathleen transferred the following assets to Mockingbird Corporation. In exchange,Kathleen received 40% of Mockingbird Corporation's only class of stock outstanding.The stock has no established value.However,all parties sincerely believe that the value of the stock Kathleen received is the equivalent of the value of the assets she transferred.The only other shareholder,Rick,formed Mockingbird Corporation five years ago.