Principles of Taxation: Advanced Strategies Slide 2-1 Principles of Taxation: Advanced Strategies Chapter 2 Organizational Strategies McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Business Organization Forms Slide 2-2 Corporations C Corporation S Corporation Pass-through Entities Unincorporated Businesses S Corporations McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Unincorporated Entities Slide 2-3 Sole Proprietorships Partnerships Limited Partnerships Limited Liability Partnerships Limited Liability Companies Disregarded Entities McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

State Taxation S Corporations Some states recognize election Slide 2-4 S Corporations Some states recognize election Some require separate state election Some tax as C Corporation Franchise Tax May be imposed on unincorporated entities McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

C Corporations Income subject to tax at corporate rates Slide 2-5 Income subject to tax at corporate rates Double Taxation Dividends taxable to shareholders Dividends received deduction Constructive Dividends McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Passthrough Entities Income taxed once to owner of entity Slide 2-6 Income taxed once to owner of entity Income taxed at owner’s rate McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Losses-C Corporations Slide 2-7 Deductible only against income earned by corporation NOL carryovers Carryback- 2 years Carryforward – 20 years McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Losses- Passthrough Entities Slide 2-8 Losses passed through to owner to offset other income Limitations Basis At Risk Passive Loss McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Debt- C Corporations Slide 2-9 Shareholders must sometimes lend money to adequately capitalize corporation Debt vs. Equity Interest deductible; Dividends nondeductible Beware of debt recharacterized as equity McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Section 351 Overview S1 and S2 control C S2 S1 Property C Stock Stock Slide 2-10 Section 351 Overview S1 and S2 control C S2 S1 Property C Stock Stock McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Section 351 Requirements Property transferred for stock Slide 2-11 Property transferred for stock Transferors control corporation after transfer Control- 80% of voting and nonvoting stock McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Section 351 Consequences Result: No gain or loss to shareholders Slide 2-12 Result: No gain or loss to shareholders Shareholder takes a substituted basis in his or her stock McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Section 351- Boot Property received by shareholders other than stock Slide 2-13 Property received by shareholders other than stock Consequences: Shareholder recognizes gain equal to lesser of fair market value of boot received or gain realized Basis of stock reduced by amount of boot received McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Section 351- Liability Assumption Slide 2-14 Generally no effect on income recognition Exceptions: No Business Purpose Debt exceeds basis of assets transferred McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Sec 351- Effect on Corporation Slide 2-15 No gain or loss to corporation on issuance of stock due to Section 1032 This would be true even if Section 351 did not apply Corporation takes carryover basis in assets McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Contributions to Corporation Capital Slide 2-16 No gain to corporation Shareholder increases basis in stock May be done by nonshareholders Often done by governments or civic groups to encourage business McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Partnership Formation Overview Slide 2-17 I2 I1 Property P Partnership Interest Partnership Interest McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Partnership Formation Slide 2-18 Partnership Formation No gain or loss to partners on receipt of partnership interest for property No control requirement Partner takes substituted basis in partnership (“outside basis”) Partnership’s basis in assets (“inside basis”) is carried over McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Disguised Sales Anti abuse rule Slide 2-19 Disguised Sales Anti abuse rule Applies when partner makes contribution of appreciated property to partnership at the same time receiving a cash distribution A portion of the property contributed is deemed sold McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Partnership Liability Assumption Slide 2-20 Treated as a nontaxable cash distribution that reduces partner’s outside basis but does not cause recognition of gain Exception: Debt relief exceeds partner’s outside basis Allocation of liability depends on whether liability is recourse or nonrecourse McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc

Sales to Controlled Entities Slide 2-21 Section 267 prevents recognition on losses incurred on sales to controlled entities Gains on sales of capital assets to controlled entities result in ordinary income to seller if asset is depreciable by buyer Gains on sales of capital assets between a partner and a controlled partnership result in ordinary income unless asset is capital asset to buyer McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc