Chapter 2 2 Corporate Formations and Capital Structure (Day 3)

Slide D3-2 IRC §351 – Special Cases Assumption of transferors’ liabilities Reduction for loss property

Slide D3-3 Assumption of Liabilities If the corporation assumes the transferors’ liabilities: The transaction is not disqualified from IRC §351 treatment [IRC §357(a)(1)] The liability assumed is generally not treated as boot [IRC §357(a)(1)]

Slide D3-4 Assumption of Liabilities Exceptions: If there is a tax avoidance purpose, the entire liability assumed is treated as boot received [IRC §357(b)(1)] If liabilities assumed > basis of the property transferred, the excess is recognized as a gain by the transferor [IRC §357(c)(1)] Exception for liabilities giving rise to a deduction when paid [IRC §357(c)(3)]

Slide D3-5 Assumption of Liabilities If the corporation assumes the transferors’ liabilities, the assumption of the liability is treated like boot for purposes of calculating the transferor’s basis in the stock received [IRC §358(d)(1)] Exception for liabilities that would give rise to a deduction when paid [IRC §358(d)(2)]

Slide D3-6 Assumption of Liabilities Problems C2-43, C2-44, C2-45

Slide D3-7 Reduction for Loss Property When total adjusted basis for all properties transferred exceeds the total fair market value of the properties, the corporation’s basis is limited to the net fair market value [IRC §362(e)(2)(A)] Reduction in basis is allocated among the properties based on relative built-in losses [IRC §362(e)(2)(B)]

Slide D3-8 Reduction for Loss Property Transferor and corporation may elect to apply the basis reduction to the transferor’s stock instead of the corporation’s assets [IRC §362(e)(2)(A)]

Slide D3-9 Example - Loss Property Jill transfers land ($122,000 adjusted basis, $100,000 FMV) to New Corp in exchange for 100% of its common stock Jill does not recognize her loss Without the election: Jill’s stock basis is $122,000 New Corp’s land basis is $100,000 With election: Jill’s stock basis is $100,000 New Corp’s land basis is $122,000

Capital Structure

Slide D3-11 Classification as Stock or Debt Form of the obligation may not control the determination of status: IRC §385(a) – Authority to prescribe regulations IRC §385(b) – Factors to consider

Slide D3-12 Debt Obligations Interest expense paid is deductible to the corporation [IRC §163(a)] Interest income received is taxable to the debt holder [IRC §61(a)(4)]

Slide D3-13 Debt Obligations Original issue discount is amortized and deducted by corporation as additional interest paid [IRC §163(e)] Amortization of OID is taxable interest income to the debt holder [IRC §1272]

Slide D3-14 Debt Obligations Premium on debt obligations is amortized and reduces the interest paid deduction of the corporation [Reg. § (a)] Debt holder can elect to deduct premium amortization [IRC §171(a) and (c)]

Slide D3-15 Debt Obligations When a corporation repays principal on its debt obligations, the repayment is generally not a taxable transaction to the corporation

Slide D3-16 Debt Obligations If a corporation repurchases its own debt obligations at price greater than the original issue price less any premium amortization or plus any discount amortization, the difference is deductible by the corporation as additional interest expense [Reg. § (c)]

Slide D3-17 Debt Obligations If a corporation repurchases its own debt obligations at price less than the original issue price less any premium amortization or plus any discount amortization, then the difference is income from the discharge of indebtedness to the corporation [Reg. § (c)(2)(ii)]

Slide D3-18 Debt Obligations When a debt holder sells or exchanges a debt obligation or receives a principal repayment, any difference between the amount realized and the debt holders’ adjusted basis is a taxable gain or loss [IRC §1001(c)]