module 6 entity formation and start-up
DESCRIPTION
Module 6 Entity Formation and Start-up. Module Topics. Transferring assets to a business: general concepts Creating the corporate capital structure Other transfers to corporations Organization costs and start-up expenses Accountant's role in business formation. - PowerPoint PPT PresentationTRANSCRIPT
Module 6Entity Formation
and Start-up
Module Topics
Transferring assets to a business: general concepts
Creating the corporate capital structure Other transfers to corporations Organization costs and start-up expenses Accountant's role in business formation
Transferring Assets to a New Business
Key Learning Objectives Tax implications of transferring assets
Sole proprietorship
Corporation
Partnership
Sole Proprietorship
Proprietor and business are one entity Need business license Employer Identification Number
Payroll taxesPayroll taxes See Module 26 for full discussion
Corporation--Formation Tax Free if §351 Applies
GENERAL RULE: No gain or loss recognized by the transferor shareholder Transfer of propertyTransfer of property In exchange for stockIn exchange for stock 80% control after transfer80% control after transfer
Gain Recognition Exception
(No Exceptions for Losses)(No Exceptions for Losses) Stock received for services performed Always income to shareholderAlways income to shareholder If stock for property and services, count both for If stock for property and services, count both for
controlcontrol Boot received
Liabilities assumed are not boot (see next slide)Liabilities assumed are not boot (see next slide) If boot, recognized gain is lesser of
Boot received orBoot received or Realized gainRealized gain
Gain Recognition Exception
(No Exceptions for Losses)(No Exceptions for Losses) Liabilities assumed by corporation
IF>basis of properties
transferred inUse aggregate amounts
If cash basis Accounts payable not liabilitiesAccounts payable not liabilities
Shareholder's Basis inStock Received
Substituted basis
Basis of property transferred in
Plus any gain recognized
Minus any boot/money received Liabilities assumed are treated as money Liabilities assumed are treated as money
herehere
Corporation's Basis in Property Received
Basis of property transferred in Plus any shareholder gain recognized
Compliance Query:Services Transferred for Stock
Taxpayer transferred services for 10 shares of stock valued at $10,000
Calculate:
Gain realized
Gain recognized
Basis in the corporate stock
Compliance Query (con’t): Services Transferred for Stock
What is Corp’s basis in the services? How should the corporation account for the
services rendered if
(1) the services were for installing equipment?(1) the services were for installing equipment? (2) the services were for preparing the (2) the services were for preparing the
corporation’s corporation’s chart of accounts? chart of accounts?
Solution--Compliance Query:Services Transferred for Stock
Services are not "property" for §351. Realize/recognize 10,000 ordinary gain Payment is subject to either FICA or self-
employment taxes
Solution--Compliance Query: Services Transferred for Stock Shareholder’s basis in stock = 10,000
CALCULATION
Basis of property transferred in 0
Gain recognized 10,000
Boot received 0
Stock basis 10,000
Solution--Compliance Query: Inventory Transferred in a §351 Transaction
Corp’s basis in services = 10,000
CALCULATION
Basis of property transferred to corporation 0
Gain recognized 10,000
Stock basis 10,000
Solution--Compliance Query:Services Transferred for Stock
Services for installing equipment Capitalize as part of the equipment's basis and Capitalize as part of the equipment's basis and
depreciate over useful lifedepreciate over useful life Services for creating chart of accounts
Capitalize as an organization costCapitalize as an organization cost Amortize it over a period of not less than 60 Amortize it over a period of not less than 60
monthsmonths
Holding Periods in §351 Transfer
Shareholder’s in stock determined by type Shareholder’s in stock determined by type of property transferredof property transferred If §1221 or §1231 = carryoverIf §1221 or §1231 = carryover Otherwise, starts day after transferOtherwise, starts day after transfer
Corporation always gets carryoverCorporation always gets carryover
Compliance Query: Inventory Transferred in a §351
Transaction
Taxpayer transferred inventory for 50 shares of stock and $6,000 in cash
Basis to Transferor Fair Market Value $48,000 $56,000
Calculate:
Gain or loss realized/recognized
Basis/holding period in the corporate stock
Corp’s basis/holding period in the inventory
Solution--Compliance Query: Inventory Transferred in a §351 Transaction
Realized gain is 8,000 56,000 - 48,00056,000 - 48,000
Recognized gain = 6,000 Gain is recognized to the extent of boot Gain is recognized to the extent of boot
received, but never more than the received, but never more than the realized gain.realized gain.
6,000 of boot was received6,000 of boot was received
Solution--Compliance Query: Inventory Transferred in a §351 Transaction
Shareholder’s basis in stock = 48,000
CALCULATION
Basis of property transferred to corporation 48,000
Gain recognized 6,000
Boot received <6,000>
Stock basis 48,000
Solution--Compliance Query: Inventory Transferred in a §351 Transaction
Corp’s basis in inventory = 56,000
CALCULATION
Basis of property transferred to corporation 48,000
Gain recognized 6,000
Stock basis 56,000
Solution--Compliance Query: Inventory Transferred in a §351 Transaction
Shareholder’s holding periodShareholder’s holding period Starts day after transferStarts day after transfer Inventory in not §1221 or §1231Inventory in not §1221 or §1231
Corp’s holding period is carryover, but Corp’s holding period is carryover, but since inventory is ordinary income asset, since inventory is ordinary income asset, gain will be ordinary regardless of holding gain will be ordinary regardless of holding periodperiod
General Rule: Partnership Formation
No gain or loss is recognized when property is contributed in exchange for a partnership interest By a partner By a partner Or the partnership Or the partnership
No 80% control test No limits on type of property
Partnership Formation: Gain Recognition Exceptions
Services performed Capital vs. Profits interest received Liabilities assumed by the other partners in
excess of partner's (adjusted) basis Investment companies Disguised sales No loss exceptions
Partner's Original Partnership Interest Basis
Cash contributed + basis of non-cash assets contributed
No adjustment for any liabilities > basis No adjustment for any liabilities > basis
+ other partners' liabilities assumed - liabilities assumed by other partners + any service gain recognized + any investment company gain
Partnership's Basis in Contributed Assets
Carryover basis for assets transferred Add any investment company gain
recognized by partner No adjustment for liabilities > basis gain
recognized Depreciation recapture potential and
holding periods also carryover
Holding Periods in Partnership Transfer
Partner’s in partnership interest is Partner’s in partnership interest is determined by type of property transferreddetermined by type of property transferred If §1221 or §1231 = carryoverIf §1221 or §1231 = carryover Otherwise, starts day after transferOtherwise, starts day after transfer
Partnership gets carryover Partnership gets carryover
Tax Avoidance Rules
5-year character rule for Inventory Inventory Capital loss propertyCapital loss property
Prevents partnership from converting use of property to avoid Inventory--ordinary income treatmentInventory--ordinary income treatment Capital loss--limitations on loss deductionsCapital loss--limitations on loss deductions
Compliance Query: Inventory Transferred To A Partnership
Taxpayer transferred inventory for 50% interest in a partnership and $6,000 in cash
Basis to Transferor Fair Market Value $48,000 $56,000
Calculate:
Gain or loss realized/recognized by partner
Basis/holding period in partnership interest
P’ship’s basis/holding period in the inventory
Solution--Compliance Query: Inventory Transferred To A Partnership
Realized/recognized gain is 0 Partner does not recognized gain on transfer
to a partnership unless money/debt relief is more than adjusted basis of property transferred to partnership
Solution--Compliance Query: Inventory Transferred To A Partnership
Shareholder’s basis in partnership = 42,000
CALCULATION
Basis of property transferred to partnership 48,000
Money/debt relief <6,000>
Partnership basis 42,000
Solution--Compliance Query: Inventory Transferred To A Partnership
Partnership’s basis in inventory = 48,000
CALCULATION
Basis of property transferred to partnership 48,000
Investment gain recognized N/A
Partnership’s basis 48,000
Solution--Compliance Query: Inventory Transferred To A Partnership
Partner’s holding periodPartner’s holding period Starts day after transferStarts day after transfer Inventory is not §1221 or §1231Inventory is not §1221 or §1231
Partnership’s holding period is carryover, Partnership’s holding period is carryover, but inventory must retain its character as an but inventory must retain its character as an ordinary income asset for 5 yearsordinary income asset for 5 years
Choice of Corporate Capital Choice of Corporate Capital StructureStructure
Key Learning Objectives Debt vs. equity
Choice of Capital Structure
StockStock
CommonCommon
PreferredPreferred DebtDebt
Debt to equity ratio importantDebt to equity ratio important
Debt issued at transfer treated as bootDebt issued at transfer treated as boot
StockGeneral Rules
§351 may apply Dividend payments are not deductible by
corporation Corporation does not have to repay equity
capital invested Stockholder has capital loss if stock becomes
worthless or is sold at a loss Unless it is §1244 stockUnless it is §1244 stock
Debt General Rules
Interest payments are deductible by corporation
Corporation must also repay principal Holder of debt has a capital loss if debt
becomes worthless or is sold at a loss Outside creditors may not like high debt to
equity ratio
Special Topics
Key Learning Objectives
Other transfers to corporations Related party transactions—§267 Losses on §1244 stock
Other Transfers to Corporations
Contributions without consideration Surrendering shares Contributions by nonshareholders Generally treated as nontaxable events
Related Party Transactions--§267
Related parties include Spouse, sibling, ancestor, descendant More than 50% owned corporations Other complex relationships
Related Party Transactions--§267
Disallowed property transaction losses Gain offset provision Unpaid expenses
Accrual basis payor deducts when cash basis Accrual basis payor deducts when cash basis payee includes in incomepayee includes in income
Related Party Transactions--§707
Applies many of §267 rules to partners and partnerships
More than 50% owned partnerships
Losses on §1244 Stock
Only first million $ of stock qualifies Only original stockholders eligible Owned by individuals, but not trusts/estates Ordinary loss treatment Limited to $50,000
$100,000 married joint$100,000 married joint
Capital Costs Incurred in Organizing a Business Entity
Key Learning Objectives
Organizational and start-up costs Deducting organizational and start-up costs Syndication costs
Organizational and Start-up Expenditures
Qualifying expenses Election Amortization Distinguish from syndication
costs
Qualifying Expenses Organizational Costs
§248 & §709 All expenses paid in creating a
business entity Expenses for drafting documents
Organizational minutes, articles, partnership Organizational minutes, articles, partnership agreements bylaws, and stock certificatesagreements bylaws, and stock certificates
Qualifying Expenses Start-up Costs--§195
All expenses incurred before beginning operations Includes investigating creation or acquisitionIncludes investigating creation or acquisition
Does not include Does not include InterestInterest TaxesTaxes Research and experimental expendituresResearch and experimental expenditures
Election and AmortizationOrganization and Start-Up Costs
Separate elections are required Election to amortize over 60 months Starting with month
Business begins--§248Business begins--§248 Active trade or business begins--§195Active trade or business begins--§195
Untimely election will be denied
Research Query:When Does Business Begin?
§248 & §709 allow amortization to start in §248 & §709 allow amortization to start in month business beginsmonth business begins
§195 allows amortization to start in month §195 allows amortization to start in month active trade or business beginsactive trade or business begins
Are these the same month?Are these the same month? Hint: Hint:
IRS Letter Rulings 9027002 & 9047032IRS Letter Rulings 9027002 & 9047032
Solution-- Research Query:When Does Business Begin?
The amortization deduction begins when The amortization deduction begins when activities have advanced to the extent activities have advanced to the extent necessary to establish the nature of the necessary to establish the nature of the business operation business operation
For start-up expenditures, the IRS follows For start-up expenditures, the IRS follows the standard of carrying on a trade or the standard of carrying on a trade or business found at §162(a) in determining business found at §162(a) in determining when a trade or business beginswhen a trade or business begins
Syndication Costs--Corporations
The costs paid to issue stock Underwriter's commissionsUnderwriter's commissions Attorney's feesAttorney's fees Printing of stock certificatesPrinting of stock certificates
Must be deducted from cost of stock.
Syndication Costs--Partnerships
Partnership interest sold as investment Includes
Printing feesPrinting fees Brokerage commissionsBrokerage commissions Mailing expensesMailing expenses
Must reduce basis in partnership interest by these amounts
Services Accounting Professionals Provide
Key Learning Objectives
Identifying the important filings Other tax and accounting
assistance