Formation of a C Corporation - Entity/ Owner Transactions

Posted on May 19, 2024

CORPORATION TAX CONSEQUENCES

Formation of a C Corporation is not taxable if the requirements of IRC Section 351 are met.

No gain or loss is recognized by the corporation in exchange of stock for property in the following situations:

Formation – issuance of common stock

Reacquisition – purchase of treasury stock

Resale – sale of treasury stock

Shareholder contributing property to the Corporation 

What is the basis of the property to the corporation when a shareholder contributes it to the corporation in lieu of the shares acquired ??

Basis to the corporation would be greater of the following

Shareholder’s adjusted basis or NBV of the property

OR

The Debt assumed by the corporation (The transferor/shareholder may recognize the gain to prevent the negative basis on the stock received in exchange for the property)

SHAREHOLDER TAX CONSEQUENCES

First it's important to understand the difference between gain or loss realized by a shareholder and gain or loss recognized by a shareholder-

Realized : is for real- that is, you actually made a gain or loss

Recognized : Related to the need or requirement for it to be recorded on your return

We calculate the realized gain or loss on the property transferred by the shareholder to the corporation by summing sum up the following:

FMV of the Stock received

Liabilities assumed by the corporation

FMV of boot (nonqualified property received by the shareholder)

From the SUM of the above, we adjust the basis of the property contributed by the shareholder to arrive at the net gain or loss realized by the shareholder on the formation of the corporation:

Does the realized gain has to be recognized - Not if the following two conditions of IRC 351 are met:

• Be part of the 80% Control Group--The shareholders or the transferors of the property to the corporation must hold at least 80% of the voting stock and at least 80% of the non-voting stock
•  No boot is received - Boot relates to cash or could even be COD- cancellation of debt

As such, gain which is realized is not necessarily recognized by the shareholders when property is transferred to the corporations in exchange of stock received, making it a non-taxable transaction.

• But if BOOT is received by the shareholder besides stock, in exchange of property - it becomes a taxable transaction.