1. Slide D1-1 Next Class Read pages 2-1 through 2-27 in the Prentice Hall textbook Examples for Chapter 2, Day 2 Chapter 2 Problems: C2-32, C2-43, C2-44, C2-45

2. Chapter 2 2 Corporate Formations and Capital Structure (Day 1)

3. Slide D1-3 Transfers to Corporations in Exchange for Stock Taxable Exchanges IRC §351 Exchanges

4. Transfers to Corporations in Exchange for Stock Taxable Exchanges

5. Slide D1-5 Shareholder/Transferor Realized gains (losses) Computation [IRC §1001(a)] Separate properties approach Amount realized [IRC §1001(b)] Liability Assumed [Reg. §1001-2(a)] Allocate on the basis of relative FMVs Adjusted basis [IRC §1011(a)]

6. Slide D1-6 Shareholder/Transferor Recognized gains (losses) In general [IRC §1001(c)] Separate properties approach Losses/related taxpayers [IRC §267(a)] Timing of test [Reg. §1.267(a)-1(a) ] Character of gains (losses) Capital, IRC §1231, or ordinary Gains/related taxpayers [IRC §1239] Timing of test [Reg. §1.1239-1(c)(3)(ii) ]

7. Slide D1-7 Shareholder/Transferor Basis of stock received Cost [IRC §1012] Cost of property is generally the sum of the cash given up, the indebtedness incurred, and the FMV of any other property given up

8. Slide D1-8 Corporation/Transferee Gain (loss) not recognized [IRC §1032(a)] Basis of property received is fair market value of the stock transferred (not the fair market value of the assets received) [Reg. §1.1032-1(d); IRC §1012; and Rev. Rul. 56-100]

9. Slide D1-9 Examples Examples Day 1: Taxable Transfers Problems Solutions

10. Transfers to Corporations in Exchange for Stock IRC §351 Exchanges

11. Slide D1-11 IRC §351 Tests Three tests for IRC §351 treatment: Property transferred to corporation Solely in exchange for corporation’s stock Control requirement Transferee corporation must not be an Investment company [IRC §351(e)]

12. Slide D1-12 IRC §351 Tests – Property Property generally includes cash and all tangible and intangible assets Property does not include the three items listed in IRC §351(d)

13. Slide D1-13 IRC §351 Tests – Stock Stock does not include nonqualified preferred stock Preferred stock is nonqualified if it meets any one of the tests in [IRC §351(g)(2)] Nonqualified preferred stock received as part of an otherwise qualifying IRC §351 transaction is treated like boot [IRC §351(g)(1)] Stock does not include stock rights or stock warrants [Reg. §1.351-1(a)(1)]

14. Slide D1-14 IRC §351 Tests – Control Person or persons that transferred property to the corporation in exchange for stock must control the corporation after the exchange [IRC §351(a)] Control defined in IRC §368(c) Control is determined immediately after the exchange [IRC §351(a)]

15. Slide D1-15 IRC §351 Tests – Control Existing shareholders may be included in transferor group if they make additional transfers in exchange for more stock Amounts transferred must not be “relatively small” in comparison to the value of the stock already owned [Reg. §1.351-1(a)(1)(ii)] For purposes of obtaining a PLR, “relatively small” means 10% or less [Rev. Proc. 77-37]

16. Slide D1-16 IRC §351 Tests – Control If stock is received in exchange for both property and services, the entire amount of stock may be included in the control test Amounts transferred for property must not be “relatively small” in comparison to the value of all the stock received [Reg. §1.351-1(a)(1)(ii)] For purposes of obtaining a PLR, “relatively small” means 10% or less [Rev. Proc. 77-37]

17. Slide D1-17 Example – Control Test Corporation X has 4,000 shares of common stock outstanding and is worth $400,000 ($100 per share). It is owned by four taxpayers as follows: A 2,000 shares B 1,000 shares C 500 shares D 500 shares If Taxpayer E transfers property worth $100,000 in exchange for 1,000 shares, is the control requirement met? No → 1,000/5,000 = 20%

18. Slide D1-18 Example – Control Test How can the control requirement be met? A 2,000 shares B 1,000 shares C 500 shares D 500 shares Have A transfer $20,000 in exchange for an additional 200 shares and B transfer $10,000 in exchange for an additional 100 shares Control test: 4,300/5,300 = 81.13%

19. Slide D1-19 IRC §351 Tests – Control Prearranged plans to dispose of stock will disqualify the exchange [Rev. Rul. 79-70; Rev. Rul. 79-194; and Rev. Rul. 2003-51] Series of prearranged and integrated steps treated as one transaction to disqualify the exchange [Rev. Rul. 54-96]

20. Slide D1-20 IRC §351 Tests – Other When more than one party is transferring property, simultaneous exchanges are not required [Reg. §1.351-1(a)(1)] Stock acquired for cash via an underwriter is a transfer of property in exchange for stock (underwriters are disregarded) [Reg. §1.351-1(a)(3)]