Question

A person who performs services for a corporation in exchange for stock cannot be treated as a member of the transferring group even if that person also transfers some property to the corporation. True or False? Please explain

Amy owns 20% of the stock of Wren Corporation, which she acquired several years ago at a cost of $10,000. Amy is Vice-President of Wren and earns a salary of $80,000 annually. Last year, Wren Corporation was experiencing financial problems, and Amy loaned the corporation $25,000. In the current year, Wren becomes bankrupt, and both her stock investment and the loan become worthless. Does Amy have a non-business bad debt deduction this year of $25,000 or is it a business bad debt deduction?   Please explain.

Beth forms Lark Corporation with a transfer of appreciated property in exchange for all of its shares. Shortly thereafter, she transfers half her shares to her son, Ted. Will the transfer to Ted cause the original transfer to be taxable? Please explain.

Answer 1

Part 1

False.

When a person only performs services for a corporation in exchange for stock cannot be treated as a member of the transferring group. The exchange of stock is treated as the payment of compensation for services performed. However, in case of transfer of some property to the corporation, along with the performance of service, he can be treated as a member of the transferring group.

Part 2

It is a business bad debt deduction

Amy is a minority shareholder of Wren Corporation. She is under compulsion to lend money to the corporation for the sake of job protection. Moreover, her stock investment is lower her annual salary.

Part 3

Yes, the transfer to Ted will cause the original transfer to be taxable

The existence of a plan, or an obligation to make the later transfer determines if the original transfer qualifies as a nontaxable exchange according to § 351. In case the property is to be transferred to Ted, Beth is not supposed to have control (80%) of Lark, and thus the transfer will be taxable.