In: Accounting
Consider whether the following transactions qualify under Internal Revenue Code Section 351:
(a) A and B are unrelated individuals. A forms Newco, Inc. on January 2 of the current year by transferring a capital asset with a basis of $10,000 and a value of $50,000 for all 50 shares of Newco common stock. On March 2, in an unrelated transaction, B transfers a capital asset with a basis of $1,000 and a value of $10,000 for 10 shares of Newco nonvoting preferred stock (that is not nonqualified preferred stock).
(b) Same as (a), above, except the transfers by A and B were part of a single integrated plan.
(c) Same as (b), above, except A transferred 25 of her 50 shares to her daughter, D as a gift on March 5 (three days after B’s transfer). What if A’s gift to D were on January 5?
(d) Same as (b), above, except that two months after B’s transfer, A sold 15 shares to E pursuant to a preexisting oral understanding, without which Newco would not have been formed.
Solution:-
(a) A and B are unrelated individuals. A forms Newco, Inc. on January 2 of the current year by transferring a capital asset with a basis of $10,000 and a value of $50,000 for all 50 shares of Newco common stock. On March 2, in an unrelated transaction, B transfers a capital asset with a basis of $1,000 and a value of $10,000 for 10 shares of Newco nonvoting preferred stock (that is not nonqualified preferred stock):-
IRC §351 applies to A’s transfer because A transferred property in exchange for stock and immediately after the transaction A had control of Newco. Therefore, A does not recognize gain and A takes a transfer basis of $10,000 in the 50 shares of Newco. stock under §358(a)(1) and a tacked Holding Period under §1223(1) assuming the transferred property is a capital asset. Newco recognizes no gain under §1032(a) and takes a transferred basis of $10,000 under §362(a).
B’s transfer is unrelated. B is therefore the only transferor on March 2. After that transfer, B does not have control of Newco. B has only 10/60 of Newco which is less than 80%. IRC §351 does not apply to B because B does not satisfy the control requirements of §368(c). B has $9k gain and takes a basis of $10k (cost basis) in his shares of Newco stock. Newco has no gain on the issuance of stock- § 1032, and has a basis of $10,000 in the property transferred by B. Treas. Reg. §1.1032-1(d).
(b) Same as (a), above, except the transfers by A and B were part of a single integrated plan:-
If the transfers were part of an integrated plan both A and B would both qualify for non-recognition under §351 because they are both the transferors, and together they control 100% of Newco. Time delay is not fatal Treas. Reg. § 1.351-1(a)(1). The fact that B received preferred stock is ok. (Preferred stock is stock that generally has less voting rights but a senior right to dividends than common stock).
(c) Same as (b), above, except A transferred 25 of her 50 shares to her daughter, D as a gift on March 5 (three days after B’s transfer). What if A’s gift to D were on January 5:-
A’s March 5 gift does not change the answer in (b) because the transferors have control, under IRC §368(c), immediately after the March 2 transfer. As long as A was not under a binding agreement prior to the transaction. If A’s gift were made on Jan. 5, then §351 does not apply b/c after B’s contribution the transferors of property (A and B) do not have control (80% of stock voting power and total number of shares of all other classes of stock) – D has > 20% common stock and D is NOT a transferor.
(d) Same as (b), above, except that two months after B’s transfer, A sold 15 shares to E pursuant to a preexisting oral understanding, without which Newco would not have been formed:-
No §351 because there was a pre-existing agreement for the transferor to sell shares of Newco at the time of the transfer. After the sale is accounted for, there is no control.. A and B would recognize gain and take a basis in Newco shares equal to fair market value. E would take a cost basis for the 15 shares.