Corporations today Essay

In the United States today there are millions of corporations in many different industries. All of them must abide by the current taxation rules and regulations that have been set by IRS and congress. The Internal Revenue Code, which was originally founded in 1939, set the foundation for the codification that we have in place today. The code arranged all Federal Tax provisions in a logical order and placed them in a separate part of the federal status. Over the years, congress has updated and amended the tax code in 1954, in 1986 Tax Reform Act, and is constantly updating the code due to its importance in assessing judicial and administrative decisions. The arrangement of the code is broken down starting with a Subtitle, broken down into chapter, subchapter, part, and then section (2). It is extremely important for Corporations today to make sure they understand the tax code so they can be aware of the benefits and consequences that may arise in daily business transactions. Asset and property transactions are a large of certain corporations day-to-day operations. Normally property and asset transactions will produce tax consequences if a gain or loss is realized. A transfer of property to a corporation in exchange for equity creates the grounds for a taxable sale and the amount to be recognized but there are exceptions to the rule (4). The code does provide exceptions to the rule and allows ways around recognizing a gain or loss upon the transfer of property to a corporation. Section 351(a) is one exception to the rule. The general rule states, â€Å"No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation†, according the internal revenue code (1). The idea and principal behind the rule is based on the transfer of property and isn’t a closed transaction because a transferor has not cashed in the position in the transferred property. Instead, the person continues to own the transferred property throughout ownership of the transferee corporation stock and there has just been a change in the form of ownership. Congress believes that tax rules should not hinder firms from making business decisions, hence why section 351 was written (10). In order for section 351 to be used and applied there are 3 items that must be met for the transaction to be considered for the non- recognition treatment. The first requirement is that there must be a transfer of â€Å"property† to a corporation. It is very important that corporations understand the definition of property because in the past issues have arose. Plant, Property, Equipment, installment obligations, and unrealized receivables of cash basis are all considered as property. The main property exclusion in the code is that services are not considered as property (6)(11). Another requirement is that the transferors must receive common or preferred stock that is not qualified preferred stock of the transferee corporation. Non-qualified preferred stock is not permitted because it has similarities to debt instruments. Stock warrants and stock rights are also excluded and would be treated as boot (7)(11). The third requirement that must be met in order for a corporation to use section 351 is that once the transfer is complete, the transferors must be in control of the transferee corporation within the meaning of section 368(c). Control means that the people involved must own a minimum of 80 percent of the total combined voting power and numbers of shares of stock. The two criteria for control both must be satisfied as per Rev. Ruling 59-259. Section 351 is a mandatory transaction if a transaction meets the provisions requirements as per Gus Russell, Inc. v. Commissioner, 36 T.C. 965 (1961)(8). If and when all of the section 351(a) requirements are met, the transferor will not recognize a gain or loss on the transfer property to the corporation. During the transaction, if the transferor receives boot, section 351(b) requires them to recognize the gain (capital, long-term, or short-term) equal to the lessor of the gain that would be recognized under section 1001 if the transferor were treated as selling property transferred and the fair market value of the boot received. Under section 351(b)(2), no such loss of any realized loss to be recognized (4)(8). There are situations where once the 351(a) factors are met, a transferor will transfer stock received to someone outside of the control group, and then the requirement after might not be met. A transferor might distribute some of the control received to the shareholders after the requirement based on 351(c). This type of distribution can be taxable to both the shareholders and the distributing corporation. Section 351(c) also relates to situations where there has been a transfer of stock to a corporation in a section 355 transactions (7). Section 351(c)(2) allows shareholders to dispose of all or part of the transfers stock without preventing the corporations Section 351 transaction from satisfying the â€Å" control immediate after† requirement (4). Section 351(d) states that there are times when services, certain indebtedness, and accrued interest not treated as property as per James v. Commissioner, 53 T.C. 63 (1969); cf. Hospital Corporation of America v. Commissioner, 81 T.C. 520 (1983). An example of this would be receiving stock for legal services (11). Even though there are major benefits to meeting the requirements of section 351, one of them being the ability to permit shareholders of a corporation to defer recognition of a gain or loss on the transfer of assets to the corporation, there are also times that it will be advantageous for a corporation to avoid using Section 351 for tax planning purposes (9). A transferor might want to be able to recognize the gain if it will not negatively affect them. If a transferor is in a low tax bracket or the gain could be a beneficial capital gain that could be offset with capital losses, they might not want to use section 351. Another scenario where it could be an advantage not to use section 351 would be if the transferor wanted to allow for immediate loss recognition. There are alternatives for a transferor who would like to recognize the loss (3). Back in March of 2005, the IRS and treasury department proposed a â€Å"net value† regulation to address the application of several non-recognition provisions to the code. The idea behind the proposal was to add the concept of â€Å"exchange of net value† requirement to Sections 332, 351, and 368(6). The reason being that a â€Å"net value† is appropriate because a transfer of property in exchange for the assumption of liabilities resembles a sale and should not be afforded. For the purposes of section 351, stock would not be treated as issued property unless the fair market value of the assets of the transferor corporation exceeds the amount of its liability immediately after the transfer (5). In conclusion, corporations need to make sure that they understand the tax codes and regulations that are set in place by the internal revenue code. Section 351 is a very interesting section and should be used in tax planning with corporations that are involved with property and asset transactions will that will produce tax consequences if a gain or loss is realized (2). In order for a corporation to use the section, all three preliminary requirements must be met. Just like any code section there are advantages and disadvantages of meeting the requirements and applying the code section to a corporation. Going forward it will be interesting to see if there will be any changes or amendments in the near future based on new court rulings. Works Cited Page (1) 26 USC Treas. Reg.  § 1.351 (2) Hoffman, Raabe, Smith, and Maloney. Corporations, Partnerships, Estates and Trusts. N.p.: South-Western, 2012. Print. (3) Richardson, William M. â€Å"Opportunities and Pitfalls Under Sections 351 and 721.† Opportunities and Pitfalls Under Sections 351 and 721. Willam and Mary, n.d. Web. (4) â€Å"Internal Revenue Code Section 351.† Www.bradfordtaxinstitute.com/Endnotes/IRC_Section_351.pdf. Bradford Tax Institute, n.d. Web. (5) Silverman, and Johnson. â€Å"Assessing the Value of the Proposed â€Å"No Net Value† Regulations.† Steptoe and Johnson LLP, 6 Oct. 2006. Web. (6) Jegen. â€Å"Section F-2033 – Income Taxation Of Corporations And Shareholders – Income Tax Effects.† Www.iupui.edu/†¦Tax/F-2033-EH.C&S.Tax.Effs.Of.Incorp.Pro.pdf. N.p., n.d. Web. (7) Leong, Lisa. â€Å"Section 351.–Transfer to Corporation Controlled by Transferor.† Associate Chief Counsel, n.d. Web. (8) Wells -Hall, C. â€Å"Tax Considerations of Transfers to and Distributions from the C or S Corporation.† Mayer, Brown, Rowe and Maw LLP, n.d. Web. (9) M&A Tax Report. â€Å"Thinking the Unthinkable: Recognizing Gain on a 351 Transfer.† Panel Publishers, n.d. Web. (10) â€Å"Corporate Formation.† Ocw.mit.edu/courses/sloan-school-of†¦/15†¦/session11.pdf. N.p., n.d. (11) â€Å"Code of Federal Regulations.† Http://www.gpo.gov/fdsys/pkg/CFR-2005-title26-vol4/xml/CFR-2005-title26-vol4-sec1-351-1.xml. Title 26 – Internal Revenue. CHAPTER I, n.d. Web.