R4 M1 - Corporate Formation
One of the elections a new corporation must make is its choice of an accounting period. Which of the following entities has the most flexibility in choosing an accounting period? A. C corporation. B. S corporation. C. Partnership. D. Personal service corporation.
*A. C corporation.* Explanation Choice "A" is correct. A C corporation has considerable flexibility in choosing an accounting period. A C corporation generally has the same choice of accounting periods as do individual taxpayers. Choice "B" is incorrect. An S corporation must adopt the calendar year unless a valid business purpose for a different taxable year is established. There are thus some restrictions on S corporations. Choice "C" is incorrect. A partnership is significantly limited in what accounting period (taxable year) it can select. Generally, a calendar year is required, unless the partnership meets a set of rules or unless the partnership can establish a valid business purpose for a different taxable year. For example, if one or more of the partners having a majority interest in the partnership's capital and profits have the same taxable year, the partnership must use that taxable year. If the partners owning a majority interest in partnership profits and capital do not have the same taxable year, the partnership must use the same taxable year as all of its "principal" partners. If neither of those two rules applies, the partnership must use the taxable year that results in the least aggregate deferral of income to the partners. Choice "D" is incorrect. A personal service corporation must generally use a calendar year unless a valid business purpose for a different taxable year is established. There are also other restrictions.
Lind and Post organized Ace Corp., which issued voting common stock with a fair market value of $120,000. They each transferred property in exchange for stock as follows: Property/ Adjusted basis/ Fair market value/ Percentage of Ace stock acquired Lind - Building/ $40,000/ $82,000/ 60% Post - Land/ $5,000/ $48,000/ 40% The building was subject to a $10,000 mortgage that was assumed by Ace. What was Ace's basis in the building? A. $30,000 B. $40,000 C. $72,000 D. $82,000
*B. $40,000* Explanation Choice "B" is correct. *Ace's basis in the building is the same as Lind's basis* immediately prior to its contribution to the corporation. Choice "A" is incorrect. Ace's basis in the building is *computed separately from any debt that it assumes related to the building*. Choice "C" is incorrect. Ace uses Lind's basis, not the building's fair market value, as its basis. Furthermore, the debt assumed by Ace does not affect the basis of the building to Ace. Choice "D" is incorrect. Ace uses Lind's basis, not the building's fair market value, as its basis.
Ames and Roth form Homerun, a C corporation. Ames contributes several autographed baseballs to Homerun. Ames purchased the baseballs for $500, and they have a total fair market value of $1,000. Roth contributes several autographed baseball bats to Homerun. Roth purchased the bats for $5,000, and they have a fair market value of $7,000. What is Homerun's basis in the contributed bats and balls? A. $0 B. $5,500 C. $6,000 D. $8,000
*B. $5,500* Explanation Rules: There is no gain or loss to the corporation issuing stock in exchange for property for the issuance of stock. The general rule is that the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation. A shareholder recognizes gain when at least 80% of both the voting and nonvoting stock is not owned by the shareholders immediately after the transaction and there is taxable boot (cash is withdrawn or cancellation of debt exists) on the transaction. *Choice "B" is correct*. The general rule is that the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation. Applying the information in the fact pattern and the above rules, there is no "shareholder gain" on this transaction. Further, there is no indication of any debt being assumed by the corporation. Thus, Homerun's basis in the contributed bats and balls is $5,500 [$500 for the baseballs plus $5,000 for the bats], which is the adjusted net book value of the transferors. Choice "A" is incorrect. Homerun's basis in the contributed bats and balls is $5,500 [$500 for the baseballs plus $5,000 for the bats], which is the adjusted net book value of the transferors. Choice "C" is incorrect. This answer option incorrectly adds the fair market value of the baseballs ($1,000) to the basis of the bats ($5,000). Homerun's basis in the contributed bats and balls is $5,500 [$500 for the baseballs plus $5,000 for the bats], which is the adjusted net book value of the transferors. Choice "D" is incorrect. This answer option incorrectly adds the fair market value of the baseballs ($1,000) to the fair market value of the bats ($7,000). Homerun's basis in the contributed bats and balls is $5,500 [$500 for the baseballs plus $5,000 for the bats], which is the adjusted net book value of the transferors.
Porter, the sole shareholder of Preston Corp., transferred property to the corporation as a contribution to capital. Two years later, Corley transferred property to the corporation in exchange for a 10% interest in corporate stock. The property transferred was valued as follows: Porter's transfer/ Corley's transfer Basis $50,000/ $250,000 Fair market value 200,000/ 500,000 What amount represents the corporation's basis in the property received? A. $700,000 B. $550,000 C. $450,000 D. $300,000
*B. $550,000* Meets 80% test = use *NBV* = *NON*taxable Does NOT meet 80% test = use FMV = Taxable Explanation Choice "B" is correct. Porter's transfer is not taxable because the 80% control test is met. The corporation's basis in the property is the basis of $50,000. Corley's transfer is taxable because the 80% control test is not met. The corporation's basis in the property is $500,000. The corporation's total basis in the properties is $550,000 ($50,000 + $500,000). Choice "A" is incorrect. $700,000 would be correct if the basis of both properties used fair market value. Choice "C" is incorrect. $450,000 would be correct if Porter's property used fair market value and Corley's property used carryover basis. Choice "D" is incorrect. $300,000 would be correct if the basis of both properties used carryover basis.
In April, X and Y formed Z Corp. X contributed $50,000 cash, and Y contributed land worth $70,000 (with an adjusted basis of $40,000). Y also received $20,000 cash from the corporation. X and Y each receives 50% of the corporation's stock. What is the tax basis of the land to Z Corp.? A. $40,000 B. $50,000 C. $60,000 D. $70,000
*C. $60,000* *Rule*: There is *no gain or loss* to the corporation issuing s*tock in exchange for property* for the issuance of stock. The general rule is that the *basis of the property received* from the transferor/shareholder is the *greater of*: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation. Choice "C" is correct. X and Y form Z Corporation so that each receives a 50% interest in the corporation. X contributes $50,000 in cash, and Y contributes land worth $70,000 and receives $20,000 from the corporation [note that each has contributed a net $50,000]. Z *Corporation* will record the *basis of the land at the basis of Y ($40,000) plus any cash it paid to secure the land ($20,000)*, or $60,000 total basis. Per the above general rule, the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation. As there is no indicated debt on the land nor any gain recognized by Y on the transfer [because X and Y own at least 80% of both the voting and nonvoting stock immediately after the transaction, the basis is the adjusted net book value of Y ($40,000) plus any cash Z Corporation pays for the land ($20,000). [Note that we have not addressed the shareholder consequences in this question.] Choice "A" is incorrect. The answer includes only Y's $40,000 basis in the land. Z Corporation will record the basis of the land at the basis of Y ($40,000) plus any cash it paid to secure the land ($20,000), or $60,000 total basis. Choice "B" is incorrect. This answer option is the amount of fair market value each shareholder was to contribute to form the corporation at inception. Because Y contributed land worth $70,000, the corporation paid Y $20,000 in cash to make each shareholder contribute $50,000 in FMV of assets. Choice "D" is incorrect. This answer option is the amount of the fair market value of the land at the date of transfer. Per the above general rule, the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation. Refer to the calculation for answer option "C".
An S corporation engaged in manufacturing has a year-end of June 30. Revenue consistently has been more than $30 million under both cash and accrual basis of accounting. The stockholders would like to change the tax status of the corporation to a C corporation using the cash basis with the same year-end. Which of the following statements is correct if it changes to a C corporation? A. The year-end will be December 31, using the cash basis of accounting. B. The year-end will be December 31, using the accrual basis of accounting. C. The year-end will be June 30, using the accrual basis of accounting. D. The year-end will be June 30, using the cash basis of accounting.
*C. The year-end will be June 30, using the accrual basis of accounting.* *Rule*: While the cash basis of accounting is used by most taxpayers for tax purposes, the accrual basis method of accounting for tax purposes is required for the following: 1. The accounting for purchases and sales of inventory, provided the business has greater than $25 million of average annual gross receipts for the three-year period ending with the prior tax year; 2. Tax shelters; 3. Certain farming corporations, provided the business has greater than $25 million of average annual gross receipts for the three-year period ending with the prior tax year; and 4. *C corporations*, trusts with unrelated trade or business income, and partnerships having a C corporation as a partner *provided the business has *greater than $25 million average annual gross receipts for the three-year period ending with the tax year.* Choice "C" is correct. The facts tell us that the shareholders would like to change the status to a C corporation using the same year-end as the S corporation (June 30). Per the above rule, C corporations with greater than $25 million average annual gross receipts must use the accrual basis of accounting for tax purposes. When this corporation changes to a C corporation status, therefore, it must report on the accrual basis of accounting for tax purposes. It will be able to stay on the June 30 year-end, as the shareholders desire. Choice "A" is incorrect. The year will be June 30 (not December 31) with the accrual (not cash) basis of accounting. Choice "B" is incorrect. The year will be June 30 (not December 31), but the accrual basis of accounting will be used. Choice "D" is incorrect. The year will be June 30, but the accrual (not cash) basis of accounting will be used
Adams, Beck, and Carr organized Flexo Corp. with authorized voting common stock of $100,000. Adams received 10% of the capital stock in payment for the organizational services that he rendered for the benefit of the newly formed corporation. Adams did not contribute property to Flexo and was under no obligation to be paid by Beck or Carr. Beck and Carr transferred property in exchange for stock as follows: Adjusted basis/ Fair market value/ Percentage of Flexo stock acquired Beck $5,000/ $20,000/ 20% Carr 60,000/ 70,000/ 70% What amount of gain did Carr recognize from this transaction? A. $40,000 B. $15,000 C. $10,000 D. $0
*D. $0* Explanation Choice "D" is correct. Carr has no taxable income because he *transferred property to Flexo* in a transaction that qualifies as *nontaxable*. Choices "A", "B", and "C" are incorrect. Beck and Carr have no taxable income because they transferred property to Flexo. However, Adams' contribution of services is not "property" for this purpose, so the receipt of stock is taxable.
Quigley, Roberk, and Storm form a corporation. Quigley exchanges $25,000 of legal fees for 30 shares of stock. Roberk exchanges land with a basis of $10,000 and a fair market value of $100,000 for 60 shares of stock. Storm exchanges $10,000 cash for 10 shares of stock. What amount of income should each shareholder recognize? Quigley/ Roberk/ Storm A. $0/ $0/ $0 B. $25,000/ $90,000/ $0 C. $25,000/ $90,000/ $10,000 D. $0/ $90,000/ $0
B. $25,000/ $90,000/ $0 Rule: IRC Section 351 controls the taxation of transfers to controlled corporations. No gain or loss is recognized to the transferors/shareholders on the property transferred if certain conditions are satisfied. Choice "B" is correct. The transaction in this question does not satisfy the conditions of Section 351, and gain or loss can be recognized for each of the shareholders. For Section 351 to apply, the shareholders contributing property, including cash, must own, immediately after the transaction, at least 80% of the voting stock and at least 80% of the nonvoting stock of the corporation. *A shareholder who contributes only services (Quigley in this question) is not counted as part of the control group*. Thus, only Roberk and Storm are counted, and they together own only 70 shares out of the 100 shares (70%). The $25,000 of legal fees to Quigley is compensation for services rendered and is recognized as income by Quigley. A gain of $90,000 (the fair market value of the land of $100,000 - its adjusted basis of $10,000) is recognized to Roberk. Storm bought shares for cash and has no gain. Choice "A" is incorrect. This is what would happen if Section 351 applies to all of the transferors/shareholders. Choice "C" is incorrect. Storm recognizes no gain of any kind since he/she merely bought shares for cash. Choice "D" is incorrect. Quigley recognizes gain since transferors who contribute only services are not counted as part of the control group for Section 351 purposes. Gain is recognized by transferors who are not part of the control group.