Question

Martha and Tom form the MT Corporation, with a transfer of the following properties:

                Martha $1,200,000 cash

               

                Tom $800,000 FMV property

                                                                $300,000 tax basis

                                               

                                                                               

Martha will receive 60% and Tom 40% of the corporate stock.

VARIATION 1: return to original facts (no Karla). Tom’s property is valued at $1,100,000 but is contributed subject to a $300,000 liability.   

VARIATION 2: Same as Variation 1 except Tom’s property is valued at $1,200,000 and is contributed subject to a liability of $400,000.

Answer 1

Variation 1: Martha's transfer of Cash of $1,200,000 represents 60% of the value of MT Corporation and Tom's property whose FMV is $800,000 represent 40% which means the value of MT Corporation is $2,000,000 . However, Tom's Property's actual value is $1,100,000 which comes with the liability of $300,000. Therefore the Primary Accounting entry in the books of MT Corporation would be

Entry 1: Cash Account Dr $1,200,000

Property Account Dr &1,100,000

To Share Capital Account $2,000,000

To Liability of Property Account $300,000

(Being Properties being bought by the stockholders along with liability)

However, the value of Tom's Property is $300,000 as per tax basis and $ 1,100,000 as per books of account which will create an issue of deferred taxation so we need to prepare the provision of deferred Tax Laibility (which will be shown under Long Term Liability in Balance sheet) of the difference amount which is $800,000 which will set off in earlier years as and when the tax laibilitywill occur. Accounting entry in the books of MT Corporation would be as follows:

Entry 2: Deferred Tax Liability Account Dr $800,000

To Property Account $800,000

(Being Deffered Tax Liability has been created on property)

Variation 1: Martha's transfer of Cash of $1,200,000 represents 60% of the value of MT Corporation and Tom's property whose FMV is $800,000 represent 40% which means the value of MT Corporation is $2,000,000 . However, Tom's Property's actual value is $1,200,000 which comes with the liability of $400,000. Therefore the Primary Accounting entry in the books of MT Corporation would be

Entry 1: Cash Account Dr $1,200,000

Property Account Dr &1,200,000

To Share Capital Account $2,000,000

To Liability of Property Account $400,000

(Being Properties being bought by the stockholders along with liability)

However, the value of Tom's Property is $300,000 as per tax basis and $ 1,200,000 as per books of account which will create an issue of deferred taxation so we need to prepare the provision of deferred Tax Laibility (which will be shown under Long Term Liability in Balance sheet) of the difference amount which is $900,000 which will set off in earlier years as and when the tax laibility will occur. Accounting entry in the books of MT Corporation would be as follows:

Entry 2: Deferred Tax Liability Account Dr $900,000

To Property Account $900,000

(Being Deffered Tax Liability has been created on property)