1
Chapter 2,
Corporate
Formations
and Capital
Structure
2
CORPORATE FORMATION
?Alternative business forms
?Check-the-box regulations
?Legal requirements for forming a
corporation
?§ 351 deferrals
?Choice of capital structure
?Worthless stock or debt obligations
3
Forms of Business
?Sole proprietorships
?Partnerships
?Corporations
?Limited liability companies
?Limited liability partnerships
4
Sole Proprietorship
(1 of 2)
?One owner
?Not a separate entity
–Income reported on Sch C of 1040
?No limited liability
?Tax advantages
–Profits taxed once
–No tax on contributions or withdrawals
–Losses other income (with limitations)
5
Sole Proprietorship
(2 of 2)
?Tax disadvantages
–Profits taxed as earned
–Owner not employee
?Profits subject to SE tax
?No tax-free fringe benefits
–No fiscal year deferral
6
Partnerships
(1 of 3)
?Two or more owners
?Conduit entity
–Reports,but does not pay income tax
?No limited liability
–Except for limited partners
7
Partnerships
(2 of 3)
?Tax advantages continued
–Losses other income (with limitations)
–Income retains its character
–Income/gain increases basis
8
Partnerships
(3 of 3)
?Tax disadvantages
–Profits taxed as earned
–Partners not employees
?Profits subject to SE tax
?No tax-free fringe benefits
–Fiscal year deferral difficult to obtain
9
Corporations
(1 of 2)
?Separate taxpaying entity
?Limited liability
?Tax advantages
–Tax rates start at 15%
–Shareholders may be employees
?No SE tax
?Eligible for tax-free benefits
–May exclude 50% of gain on stock
sale if certain requirements met
10
Corporations
(2 of 2)
?Tax disadvantages
–Double taxation of income
?Corp and s/h level
–Withdrawals (dividends) taxable
–NOLs cannot be used in current year
–Capital losses cannot offset
ordinary income
11
Limited Liability Companies
?Limited liability for all owners
?No ownership restrictions
?May be taxed as partnership or
corporation
12
Limited Liability Partnership
?Partners liable for only their own
actions
–No liability for negligence or
misconduct of other partners
?May be taxed as either a
partnership or corporation
13
Check-the-Box Regulations
?Unincorporated entities choose to be
taxed as partnership or corp
–Sole proprietor or corp if one owner
?Entity must choose tax status or
?accept default status
–Partnership (sole proprietor if one owner)
14
Requirements to
Incorporate
?Dependent on state law
?Minimum capital requirements
?File of articles or incorporation
?Granting of charter by state
?Issue of stock
?Pay state incorporation fees
15
§ 351 Deferrals
(1 of 2)
?No gain or loss recognized if,
–PROPERTY transferred in exchange
for stock and
–Transferors have control of corp
immediately after the exchange
?Transfers may be for new or
existing corporations
16
§ 351 Deferrals
(2 of 2)
?Stock requirement
?Tax effects on transferors
?Tax effects on transferee corp
?Assumption of liabilities
17
§ 351 Deferrals,
Property Requirement
?Property does not include,
–Services
–Indebtedness of transferee not
evidenced by a security
–Interest on indebtedness of transferee
that accrued on or after beginning of
transferor’s holding period for the debt
18
§ 351 Deferrals,
Control Requirement
?Transferors must own at least,
–80% of total combined voting power
of all classes of stock and
–80% of total number of shares of all
other classes of stock
?Contribution of services & property
–Stock of transferor counted towards
80% if FMV of property ? 10% of
service’s value
19
§ 351 Deferrals,
Tax Effects on Transferors (1 of 2)
?General rules
–No gain or loss recognized
–Basis in stock same as basis in
property (carryover basis)
–Carryover holding period of stock
20
§ 351 Deferrals,
Tax Effects on Transferors (2 of 2)
?When boot received
–Gain recognized lesser of gain
realized or FMV of boot received
–Basis in stock increased by gain
recognized
–Basis in boot property is FMV
–Holding period of boot begins day
after exchange
21
§ 351 Deferrals,
Tax Effects on Transfee Corp
?No gain or loss recognized
?Basis in property received
–Transferor’s adjusted basis plus
–gain recognized
22
Choice of Capital
Structures
Debt
? Interest deductible by
corp
? Repayment of debt
not taxable to s/h
? Debt received in
§ 351 is boot to s/h
? Worthless debt is
capital loss to s/h
? Debt distributed by
corp taxable to s/h
Equity
? Dividends not deductible
by corp
? Stock redemption can be
taxable dividend to s/h
? Stock received in § 351
not boot to s/h
? Worthless § 1244 stock
is ordinary loss to s/h
? Stock distributed b corp
not taxable to s/h
23
Worthless Stock or Debt
(1 of 3)
?Investment evidenced by a security
that becomes worthless produces a
capital loss on last day of tax year
?Securities include,
–Stock of a corporation
–Rights to subscribe for stock to be
issued
–Evidence of indebtedness
24
Worthless Stock or Debt
(2 of 3)
?Ordinary Loss Situations
–Securities that are noncapital assets
–Securities of affiliated companies
–§ 1244 stock
25
Worthless Stock or Debt
(3 of 3)
?§ 1244 stock
–Qualifying small business stock
–Must be the original purchaser
–Ordinary loss up to $50k or $100k if
MFJ
–Corp must have received $1M or less
of property in exchange for stock
26
Comments or questions about PowerPoint Slides?
Email Richard Newmark at Dr.Newmark@PhDuh.com
Chapter 2,
Corporate
Formations
and Capital
Structure
2
CORPORATE FORMATION
?Alternative business forms
?Check-the-box regulations
?Legal requirements for forming a
corporation
?§ 351 deferrals
?Choice of capital structure
?Worthless stock or debt obligations
3
Forms of Business
?Sole proprietorships
?Partnerships
?Corporations
?Limited liability companies
?Limited liability partnerships
4
Sole Proprietorship
(1 of 2)
?One owner
?Not a separate entity
–Income reported on Sch C of 1040
?No limited liability
?Tax advantages
–Profits taxed once
–No tax on contributions or withdrawals
–Losses other income (with limitations)
5
Sole Proprietorship
(2 of 2)
?Tax disadvantages
–Profits taxed as earned
–Owner not employee
?Profits subject to SE tax
?No tax-free fringe benefits
–No fiscal year deferral
6
Partnerships
(1 of 3)
?Two or more owners
?Conduit entity
–Reports,but does not pay income tax
?No limited liability
–Except for limited partners
7
Partnerships
(2 of 3)
?Tax advantages continued
–Losses other income (with limitations)
–Income retains its character
–Income/gain increases basis
8
Partnerships
(3 of 3)
?Tax disadvantages
–Profits taxed as earned
–Partners not employees
?Profits subject to SE tax
?No tax-free fringe benefits
–Fiscal year deferral difficult to obtain
9
Corporations
(1 of 2)
?Separate taxpaying entity
?Limited liability
?Tax advantages
–Tax rates start at 15%
–Shareholders may be employees
?No SE tax
?Eligible for tax-free benefits
–May exclude 50% of gain on stock
sale if certain requirements met
10
Corporations
(2 of 2)
?Tax disadvantages
–Double taxation of income
?Corp and s/h level
–Withdrawals (dividends) taxable
–NOLs cannot be used in current year
–Capital losses cannot offset
ordinary income
11
Limited Liability Companies
?Limited liability for all owners
?No ownership restrictions
?May be taxed as partnership or
corporation
12
Limited Liability Partnership
?Partners liable for only their own
actions
–No liability for negligence or
misconduct of other partners
?May be taxed as either a
partnership or corporation
13
Check-the-Box Regulations
?Unincorporated entities choose to be
taxed as partnership or corp
–Sole proprietor or corp if one owner
?Entity must choose tax status or
?accept default status
–Partnership (sole proprietor if one owner)
14
Requirements to
Incorporate
?Dependent on state law
?Minimum capital requirements
?File of articles or incorporation
?Granting of charter by state
?Issue of stock
?Pay state incorporation fees
15
§ 351 Deferrals
(1 of 2)
?No gain or loss recognized if,
–PROPERTY transferred in exchange
for stock and
–Transferors have control of corp
immediately after the exchange
?Transfers may be for new or
existing corporations
16
§ 351 Deferrals
(2 of 2)
?Stock requirement
?Tax effects on transferors
?Tax effects on transferee corp
?Assumption of liabilities
17
§ 351 Deferrals,
Property Requirement
?Property does not include,
–Services
–Indebtedness of transferee not
evidenced by a security
–Interest on indebtedness of transferee
that accrued on or after beginning of
transferor’s holding period for the debt
18
§ 351 Deferrals,
Control Requirement
?Transferors must own at least,
–80% of total combined voting power
of all classes of stock and
–80% of total number of shares of all
other classes of stock
?Contribution of services & property
–Stock of transferor counted towards
80% if FMV of property ? 10% of
service’s value
19
§ 351 Deferrals,
Tax Effects on Transferors (1 of 2)
?General rules
–No gain or loss recognized
–Basis in stock same as basis in
property (carryover basis)
–Carryover holding period of stock
20
§ 351 Deferrals,
Tax Effects on Transferors (2 of 2)
?When boot received
–Gain recognized lesser of gain
realized or FMV of boot received
–Basis in stock increased by gain
recognized
–Basis in boot property is FMV
–Holding period of boot begins day
after exchange
21
§ 351 Deferrals,
Tax Effects on Transfee Corp
?No gain or loss recognized
?Basis in property received
–Transferor’s adjusted basis plus
–gain recognized
22
Choice of Capital
Structures
Debt
? Interest deductible by
corp
? Repayment of debt
not taxable to s/h
? Debt received in
§ 351 is boot to s/h
? Worthless debt is
capital loss to s/h
? Debt distributed by
corp taxable to s/h
Equity
? Dividends not deductible
by corp
? Stock redemption can be
taxable dividend to s/h
? Stock received in § 351
not boot to s/h
? Worthless § 1244 stock
is ordinary loss to s/h
? Stock distributed b corp
not taxable to s/h
23
Worthless Stock or Debt
(1 of 3)
?Investment evidenced by a security
that becomes worthless produces a
capital loss on last day of tax year
?Securities include,
–Stock of a corporation
–Rights to subscribe for stock to be
issued
–Evidence of indebtedness
24
Worthless Stock or Debt
(2 of 3)
?Ordinary Loss Situations
–Securities that are noncapital assets
–Securities of affiliated companies
–§ 1244 stock
25
Worthless Stock or Debt
(3 of 3)
?§ 1244 stock
–Qualifying small business stock
–Must be the original purchaser
–Ordinary loss up to $50k or $100k if
MFJ
–Corp must have received $1M or less
of property in exchange for stock
26
Comments or questions about PowerPoint Slides?
Email Richard Newmark at Dr.Newmark@PhDuh.com
