Business Heaven/Business Heaven.iso/accnting/sba93_4/f304.sbe

Text File | 1993-07-01 | 11KB | 297 lines

@Q01

  ┌────────────────────────────────────────────────────────┐
  │CAN I INCORPORATE MY BUSINESS IN A TAX-FREE TRANSACTION?│
  └────────────────────────────────────────────────────────┘

If you transfer money or other property to a controlled cor-
poration in exchange for stock of the corporation, either to
capitalize a new corporation or to add to the capital of a
corporation that already has assets, the general rule is
that you will not recognize any taxable gain or loss on the
transaction.  However, for such a transfer to qualify, the
tax law requires that the person or persons who transfer the
property or money must control AT LEAST 80% of the voting
stock of the corporation and at least 80% of the shares of
any other classes of stock, immediately after the exchange.

QUESTION:  Will you, together with any other transferors in
  the same transaction, own at least 80% of the voting stock
  and 80% of each other class of stock of the corporation, im-
  mediately after the proposed exchange of assets for stock?
@YN
01\Q03
02\Q02

@Q02

CONCLUSION:  Your transfer of assets to the corporation will
not technically qualify as non-taxable.

However, note that you won't necessarily have to recognize
taxable gain if the only kinds of assets you transfer to the
corporation in exchange for the stock or securities you re-
ceive are the following:

                . Money; or

                . assets that do not have a value in excess
                  of their tax basis; or,

                . a combination of the above.

@STOP

@Q03

So far, so good.  It appears that a transfer of assets to
your corporation for stock (and possibly for notes, bonds or
other securities to be issued by the corporation) should qua-
lify as "nontaxable" under Section 351 of the tax code.
However, things are rarely that simple under our tax system.
Your "nontaxable" transaction may still be taxable, at least
in part, if you receive anything other than stock of the cor-
poration in exchange for the assets you transfer into the
corporation (such as promissory notes, other securities,
cash, or other property).  Anything you receive back from the
corporation in the transaction, other than its own common or
preferred stock, will be considered "boot," and any "unreal-
ized gains" on property transferred to the corporation will
be taxable, in an amount equal to the smaller of:  (a) such
unrealized gain, or (b) the amount of "boot" received.

QUESTION:  Will you receive any "boot" (money or any other
    kind of property, other than stock issued by the corpor-
    ation in question) on the transaction?
@YN
01\Q04
02\Q07

@Q04

CONCLUSION:  Then you may have to pay tax on this so-called
"nontaxable" transfer of assets to your corporation.  But
NOT if the only assets you transfer to the corporation are
the following:

  . Cash; and/or

  . Assets which have tax basis equal to or greater than
    fair market value at the time of the transfer.  (You can
    usually ignore accounts receivable of a cash-basis busi-
    ness, even though they have a zero tax basis, although
    this can get somewhat technical in some cases.)

QUESTION:  Will you be transferring any property to the cor-
    poration (other than accounts receivable of a cash-basis
    business) that has a value greater than its tax basis?

@YN
01\Q05
02\Q06

@Q05

FURTHER CONCLUSION:  Then it appears you will have to recog-
nize some or all of the "unrealized appreciation" as taxable
gain on the incorporation or transfer of assets to your cor-
poration, in this so-called "nontaxable" transfer.

Note that the maximum amount of gain you must recognize, re-
gardless of how much "boot" you receive, will not exceed the
amount of your "unrealized gain" on the property (i.e., the
amount, if any, by which the value of any item or items of
property exceeds the tax basis of such items).  (Tax "basis"
is usually, but not always, the cost of an asset.)

This may not be entirely bad, however, since the corporation
will obtain a "step-up" in its tax basis for any assets on
which you have to report taxable gain on the transfer.

                ┌──────────────────────────────────────┐
                │ EXAMPLE:  If you report a $1,000 tax-│
                │ able gain on  transfer of  a computer│
                │ to the  corporation,  the corporation│
                │ will be allowed  to increase its "tax│
                │ basis"  for the  computer  by $1,000,│
                │ which will give it additional deprec-│
                │ iation deductions  over the period in│
                │ which it depreciates the computer.   │
                └──────────────────────────────────────┘

@STOP

@Q06

FURTHER CONCLUSION:  Then there appears to be virtually no
possibility that you will have any taxable gain to recognize
on the transfer of assets to your corporation, since there
is no gain to recognize where you have no appreciated assets
(assets with a value in excess of tax basis) that you are
transferring in the transaction.

CAUTION:  You should still consult a competent tax profes-
sional before you transfer any assets to a corporation.
Even if the transfer itself is nontaxable, there can be
other ramifications which might make such a transfer
hazardous to your financial health!

FURTHER CAUTION:  If, as part of the transaction, you re-
ceive some of the stock in the corporation IN EXCHANGE FOR
SERVICES (prior services, or to be rendered in the future),
then you will have to report as income the value of the
stock received for such services.  Tax-free treatment is
only allowed for transfers of PROPERTY to a controlled cor-
poration in exchange for stock, not for transfers of
SERVICES.

@STOP

@Q07

CONCLUSION:  Even if you receive no "boot" on the proposed
transfer of assets to your corporation in exchange (only) for
its stock, you still aren't necessarily home free.  If you
transfer an asset to the corporation that is subject to a
debt that exceeds its its tax basis, the excess of the amount
of the debt assumed by the corporation (or taken "subject to"
by it) over the tax basis of the asset is a taxable gain.  For
example, if you transfer a piece of land with a cost of
$30,000 to the corporation, subject to a mortgage of $35,000,
and with a current value of $50,000, you will recognize a tax-
able gain of $5,000 ($35,000 - $30,000), regardless of the
value of the land.  However, if you had placed the mortgage
on the property just before the transfer, for TAX AVOIDANCE
PURPOSES, the entire $35,000 mortgage would be treated as
"boot" and you would recognize the full $20,000 gain ($50000
"boot" minus your $30000 basis.)
  QUESTION:  Does the debt on any property to be transferred
to the corporation exceed its "tax basis," or was debt placed
on the property in advance for "tax avoidance purposes"?
@YN
01\Q08
02\Q09

@Q08

FURTHER CONCLUSION:  Then you will probably incur taxable
gain, to at least the extent by which the debt exceeds the
tax basis of the asset in question, and perhaps an even lar-
ger gain if the IRS and the courts decide that you took on
the debt for tax avoidance purposes before it was trans-
ferred to the corporation.

@STOP

@Q09

FURTHER CONCLUSION:  Then it appears that you should be able
to do the transfer of assets to your corporation on a non-
taxable basis, without recognizing either gain or loss on
the transaction.  However, because the tax law in this area
is quite technical and complex, with many potential ramifi-
cations and traps for the unwary, it is STRONGLY recommended
that you consult a good tax advisor before you transfer any
kind of assets to a corporation.

CAUTION:  If, as part of the transaction, you receive some
of the stock in the corporation IN EXCHANGE FOR SERVICES
(prior services, or to be rendered in the future), then you
will have to report as income the value of the stock re-
ceived for such services.  Tax-free treatment is only al-
lowed for transfers of PROPERTY to a controlled corporation
in exchange for stock, not for transfers of SERVICES.

@STOP

@HELP

@H\01

Note that the  Internal Revenue Service
and at  least one  federal  court  have
held that,  in addition to the 80% con-
trol requirement, there must be a valid
business  purpose in order for a trans-
fer  to  a  controlled  corporation  to
qualify for tax-free treatment.

(Note also that even if a transfer does
not qualify as "non-taxable,"  there is
no  taxable gain  to recognize  if only
cash is transferred to the corporation,
or assets that have  not appreciated in
value beyond their "tax basis.")

@H\02

Note also, that where "control" is ab-
sent,  as you have indicated  would be
the case in your situation, you may be
able to even recognize a taxable loss,
if you  exchanged an asset  that has a
tax basis  that is  greater than  fair
market value.

@H\03
Until  October 3, 1989,  you could re-
ceive  "securities" (bonds,  long-term
notes and the like)  from the corpora-
tion also, but since then any such se-
curities are treated like "boot."

(Note  that if you  transfer  property
having a tax basis of only $3,000, but
worth $10,000, to a controlled corpor-
tion,  you would have $7,000 of poten-
tially taxable "unrealized gain."   If
you receive  $2,000 of boot in the ex-
change of assets  for stock  and boot,
you will have  taxable gain, but limi-
ted to the amount of the boot--$2000.)

@H\04

Cash (U.S. money)  always has a tax ba-
sis equal  to its value,  so no gain is
possible,  if all  you transfer  to the
corporation is money.

Similarly,  if you only  transfer other
kinds of property that you would have a
loss on if sold for current fair market
value,  there is no  taxable gain to be
recognized,  even if you receive "boot"
on the transaction.  (However, you will
not be  allowed to  recognize the loss,
if any, on the exchange.)

@H\05

"Unrealized appreciation" is simply the
amount by  which the value  of an asset
transferred to  the corporation exceeds
its tax basis.  This "unrealized appre-
ciation" remains "unrealized" (untaxed)
in transfers to  a controlled  corpora-
tion,  unless there is  "boot" received
on the transaction,  or liabilities are
taken on by the corporation that exceed
the tax basis of assets transferred, or
liabilities are taken on by the corpor-
ation  that were  created by the trans-
feror for tax avoidance motives.

@H\07

CAUTION:   Even if you  don't  feel you
took  on a  debt  (that is being trans-
ferred to the  corporation)  for a "tax
avoidance" purpose,  you should realize
that the IRS will  probably consider it
as  tax avoidance  if you  incurred the
debt within  a year or  less before the
transfer  (or  perhaps  even  longer in
some instances).

@END