Question

Sub: Advanced Federal Taxation

Bob and Betty have a partnership that owns 18 clothing stores located in various states in the US. They are thinking converting their business into a corporation and then using some money they have accumulated to acquire a small chain of men's clothing stores located in Virginia or they might issue common stock from their new corporation to buy the other business.

Explain the tax consequences of forming the corporation from the partnership.

Explain the tax consequences of acquiring the chain of men's clothing stores.   

Answer 1

Tax consequences of forming the corporation from the partnership

There are two sections we need to unerstand

IRC Section 351 & Section 358

Pursuant to IRC sec 351, if there is any partner's interest contributes directly to the corporation, upon liquidating the assets, the gain on the transactions may qualify under this section to defer the recognition of gain by the partners.

Pursuant to IRC sec 358, if a partnership firm, transfers its assets and liabilities to new corporation, then it may not recognize gain or loss, and in this transaction, the partnership basis in the stock received equals basis in the assets and there is no taxable gain or loss to the partnership firm. The partnership may face gain or loss if internal assets are liquidated

Hence, in the above, Bob and Betty, can form S corporation which suits the requirement and there may not be gain or loss to be recognized and the partner's interest/stock in 18 cloting stores, just convert as assets in the new corporation.

Liability & Taxation - S Corporation:

a) Only one level of taxation - to Shareholders (applicable Corporate Tax instead of Individual Tax)

b) Corporation can have only one level class of stock

c) Limited legal Liability

d) No special allocation rules to sharesholders to appreciate property

Tax consequences of acquiring chain of men's cloting stores:

As the partners dealt with single class of stock, based on the common stock of S Corp, Bob and Betty can acquire the business of men's stores at Virginia and it is beneficial to Bob and Betty to convert the firm into S Corp, as the acquistion attracts less tax rate ( from 30% to 6%) than of an acquistion based on partnership