To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER CORPORATIONS: ORGANIZATION AND CAPITAL STRUCTURE SOLUTIONS TO PROBLEM MATERIALS Question/ Problem Learning Objective LO LO *4 LO LO LO LO *7 LO LO 1, 2, LO 10 LO 11 12 LO LO 13 LO 14 15 LO LO 16 LO 17 LO Topic Compare § 351 and § 1031 in terms of justification and effect Possible gain and/or loss recognition on a § 351 transfer Stock issued for services Taxation of boot received Receipt of a note in exchange for property transferred to a controlled corporation Explain control requirement of § 351; effect of specific situations on control requirement Incorporating a new business Types of consideration received in exchange for property; alternatives other than stock Charitable gift of stock shortly after § 351 exchange Transfer of property and services for stock by multiple shareholders Transfers to an existing corporation Potential for gain recognition on transfer of mortgaged property Bona fide business purpose requirement in transfer of liabilities to a controlled corporation Rationale for § 357(c) Impact of various attributes on stock basis calculation When stock issued for services is deductible/not deductible Holding period rules for corporation and shareholder contrasted Status: Present Edition Q/P in Prior Edition Unchanged Unchanged Modified New Modified Unchanged New Modified Modified New Unchanged New 11 Unchanged 13 Unchanged Modified 14 15 Unchanged 16 Modified 17 Instructor: For difficulty, timing, and assessment information about each item, see p 4-4 4-1 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 4-2 2012 Corporations Volume/Solutions Manual Question/ Problem Learning Objective 18 LO 19 LO *20 LO 21 LO 22 LO 23 LO 24 25 *26 LO 1, LO LO 1, *27 LO 1, 28 LO 1, 29 LO 30 31 *32 33 LO LO LO 1, LO 1, 34 35 LO LO 1, *36 LO 1, 2, 37 LO 1, 2, *38 *39 LO 1, 2, LO 1, *40 LO 1, 2, 41 42 43 LO 1, LO 1, LO 1, Topic Basis rules for property acquired from a shareholder and from a nonshareholder Advantages of utilizing debt in the capitalization of a corporation Relevant factors in reclassification of debt as equity Tax treatment of worthless stock when § 1244 does not apply Shareholder loan to corporation: business or nonbusiness bad debt? Tax treatment in selected situations where corporate stock has declined in value Selection of assets to transfer to corporation Selection of assets to transfer to corporation Formation of corporation; gain or loss on transfer; transfers of appreciated and built-in loss property, services, liabilities; basis computations Formation of corporation; gain on transfer; basis of stock; basis of property Formation of corporation with transfer of property from several shareholders at different times Transfer of property to a corporation after date of formation of corporation Transfers to existing corporation Transfer of property to existing corporation Transfer of property and services for stock Formation of corporation; transfer of services for stock Stock received for services rendered Transfers to existing corporation; transfer of nominal amount of property Shareholder liabilities assumed by corporation in excess of basis of assets transferred Corporate formation: gain or loss recognized; stock basis; property basis to the corporation Application of § 357(b) and § 357(c) Basis adjustment for loss property in a § 351 transaction Incorporation of cash basis business; effect of trade payables Stock received for services rendered Stock received for services rendered Depreciation recapture in a § 351 transfer Status: Present Edition Q/P in Prior Edition Unchanged 18 Unchanged 19 Unchanged 20 New Unchanged 22 Modified 23 Unchanged Unchanged Modified 24 25 26 Modified 27 Unchanged 28 New Unchanged New New New 30 Modified Modified 34 35 Modified 36 Unchanged 37 New Modified 39 Unchanged 40 Unchanged Unchanged Modified 41 42 43 Instructor: For difficulty, timing, and assessment information about each item, see p 4-4 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Organization and Capital Structure Question/ Problem *44 Learning Objective LO 45 LO 5, 46 47 LO 5, LO 48 LO 49 50 LO LO 5, Topic Contribution to corporation by nonshareholder Investor losses; business versus nonbusiness bad debts Reclassification of debt as equity Section 1244 stock; transfer of § 1244 stock to another individual Transfer of § 1244 stock to another individual Section 1244 stock; determination of loss Reclassification of debt as equity; debtequity ratio 4-3 Status: Present Edition Q/P in Prior Edition New Unchanged 45 Unchanged Unchanged 46 47 Unchanged 48 Unchanged Unchanged 49 50 *The solution to this problem is available on a transparency master Instructor: For difficulty, timing, and assessment information about each item, see p 4-4 Research Problem Topic Transfer of property to investment company; gain recognition Using a note to avoid § 357(c) Avoiding the application of § 351 rules Abandonment loss Internet activity Internet activity Internet activity Status Present Edition Q/P in Prior Edition Unchanged Unchanged New Unchanged New Unchanged Unchanged © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 4-4 2012 Corporations Volume/Solutions Manual Question/ Problem Est'd completion time Difficulty 5 Assessment Information AICPA* AACSB* Core Comp Core Comp Easy Easy Easy Easy Easy Medium 5 10 Medium 10 Medium 10 10 11 Easy Easy Medium 5 10 12 Easy 10 13 Easy 14 Easy 15 16 Medium Easy 17 18 19 Easy Easy Easy 5 20 Easy 10 FN-Reporting 21 22 23 Easy Easy Medium 10 10 24 Medium 10 25 Medium 10 26 Medium 15 27 Medium 15 28 Medium 10 FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting 10 FN-Reporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting FN-Measurement FN-Measurement FN-Measurement Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic | Reflective Thinking *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Organization and Capital Structure Question/ Problem Difficulty Est'd completion time 29 Medium 15 30 Medium 10 31 Easy 32 Medium 10 33 Medium 10 34 Easy 35 Hard 15 36 Medium 10 37 Medium 10 38 Medium 10 39 Hard 15 40 Medium 10 41 Medium 10 42 Medium 10 43 Medium 10 44 Easy 10 45 Medium 15 46 Medium 20 47 Easy 48 Easy 15 49 Easy 10 50 Medium 10 4-5 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting Communication | Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic | Reflective Thinking Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Communication | Analytic Communication | Analytic Analytic Communication | Analytic Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 4-6 2012 Corporations Volume/Solutions Manual CHECK FIGURES 26.a 26.b 26.c 26.d 26.e 26.f 26.g 26.h 26.i 26.j 26.k 27.a 27.b 27.c 27.d 27.e 27.f 27.g 27.h 28.a 28.b 28.c 29 31 32.a 32.b 32.c 33 34 $7,000 $30,000 $37,000 $9,000 $55,000 $64,000 $0 $25,000 $25,000 $0 $30,000 $0 $180,000 $140,000 $0 $264,000 $120,000 equipment; $4,000 patent No change No change None recognizes gain $260,000 Clyde’s transfer should be independent of the others $650,000 recognized gain $510,000 recognized gain Ann $0; Bob $15,000 Ann $150,000; Bob $45,000 $150,000 basis in property Ann transferred; $30,000 basis in property Bob transferred; $15,000 basis in organizational expenditures Both Ann and Bob recognize gain/income Kim ordinary income of $10,000 on receipt of stock; Azure’s § 162 deduction of $40,000 35.a 35.b 36 38 39.a 39.b 39.c 39.d 40 41.a 41.b 42.a 42.b 43 44.a 44.b 44.c 47.a 47.b 48 49.a 49.b 49.c Rhonda recognizes $185,000 gain Rhonda still recognizes $185,000 gain No gain recognized; Natalie’s stock basis $90,000; Brown’s basis in assets $450,000 David’s recognized gain $250,000, stock basis $200,000; White’s basis in land $450,000 Loss not recognized Stock basis $290,000 Inventory, $60,000; delivery vehicles, $125,000; shelving, $75,000 Reduce Michael’s stock basis to $260,000 rather than reducing Peach’s basis in property No gain recognized Sara no gain; Jane income $15,000 $25,000 in property from Sara; $10,000 in property from Jane; deduction of $15,000 for services $15,000 $10,000; capitalize Donna recognizes no gain; Jay ordinary income $65,000; basis $30,000 in machinery $0 $0 $0 basis for building; $0 basis for inventory Ordinary loss $50,000; long-term capital loss $40,000 Long-term capital loss $40,000 Long-term capital loss $15,000 $50,000 $25,000 $5,000 ordinary loss; $25,000 capital loss © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Organization and Capital Structure 4-7 DISCUSSION QUESTIONS Both § 351 and § 1031 provide for nonrecognition of gain or loss for certain transfers which otherwise would be taxable The principle behind the nonrecognition of gain or loss is the concept of continuity of the taxpayer’s investment As there is no real change in the taxpayer’s economic status, gain or loss should be postponed until such a change occurs (i.e., a sale to or a taxable exchange with outsiders) In addition, this approach can be justified under the wherewithal to pay concept discussed in Chapter pp 4-2 and 4-3 Gain is recognized on a § 351 transfer if the transferor receives “boot” in the exchange (i.e., money or property other than stock) Gain is recognized to the extent of the lesser of the gain realized or the boot received (the amount of money and the fair market value of the other property received) The nature of any gain recognized is characterized by reference to the type of asset transferred Loss is never recognized in a § 351 transaction pp 4-3 and 4-4 Services are not considered to be property under § 351; therefore, Presley must report as income the fair market value of the Red stock received Presley’s basis in the stock will be its fair market value Example The transfer or release of a liability is normally treated as the receipt of boot by the transferor But such boot is taxed only to the extent of any realized gain that results Although § 357(a) exonerates liabilities from boot treatment in § 351 transfers, it contains two exceptions One exception, § 357(c), provides for gain recognition on the excess of the liability over the basis of the property transferred The exception creates gain and applies regardless of whether realized gain is present pp 4-9 and 4-10 Yes A 10-year note as well as cash, securities, and other property constitute boot under § 351 Nonqualified preferred stock is also treated as boot because this type of stock has characteristics that are similar to debt Therefore, its receipt is treated the same as the receipt of securities p 4-5 The control requirement specifies that the person or persons transferring property to the corporation must own, immediately after the transfer, stock possessing at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation Control may apply to a single person or to several taxpayers if they are all parties to an integrated transaction pp 4-5 and 4-7 a If a shareholder renders services to the corporation for stock, the control requirement can be lost as to the other shareholders The shareholder rendering services, absent any additional transfer of property for stock, cannot qualify under § 351 because services rendered are not ‘‘property.” For example, if Adam transfers property to Brown Corporation for 50% of the stock and Bonnie receives 50% of the stock for services rendered, the transaction is taxable to both Adam and Bonnie Bonnie is not a member of the group transferring property, and Adam receives only 50% of the stock The post-control requirement is not met Example b If a shareholder renders services and transfers property to the corporation for stock, the shareholder is treated as a member of the transferring group although taxed on the value of the stock received for services Consequently, in part a above, if Bonnie also transferred property, the transaction would qualify under § 351 To be a member of the group and to aid in qualifying all transferors under the 80% test, the person contributing services must transfer property having more than a relatively small value in relation to the services he or she performed Examples 10 and 11 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 4-8 2012 Corporations Volume/Solutions Manual c If a shareholder has only momentary control of the stock of the corporation after the transfer, these shares not count in determining control if the plan for ultimate sale or other disposition of the stock existed before the exchange Example d If a long period of time elapses between the transfers of property by different shareholders, the control requirement may be lost as to the later transfers because there is no transferring group The Regulations affirm that an exchange involving more than one person does not necessarily require simultaneous transfers by the persons involved, but there must be a transaction in which the rights of the parties were previously defined and the transaction occurs shortly thereafter Transfers that involve a long lapse of time should be properly documented as part of a single plan Contrast Examples and • Is the secret process property for purposes of Đ 351? Do the transfers qualify under Đ 351? If the transfers qualify under Đ 351, will Kevin be taxed on the stock received in exchange for the services he renders to Crow Corporation? • What is Crow’s basis in the secret process? • Will Crow Corporation have a tax deduction for the value of the stock it transfers to Kevin for the services he renders? Example and related discussion If the real estate is appreciated, either approach results in gain being recognized by Charlie The receipt of bonds (i.e., securities) results in a sale of the real estate, and the realized gain is recognized The mortgage scenario yields a like consequence One possible alternative is to use preferred stock This could give Charlie more security than common stock, particularly if the preferred stock has a liquidation preference To be nontaxable, however, the transfer should be tied to the original incorporation of the business Otherwise, the 80% control requirement might not be satisfied In addition, to avoid being considered boot, the preferred stock received must not meet the definition of nonqualified preferred stock pp 4-5 and 4-9 It appears that the exchange qualifies under § 351 Control is not lost if stock received by a shareholder in a § 351 exchange is sold or given to others shortly after the exchange unless there was a binding agreement for such transfer Assuming the subsequent transfer is completely donative, it should be disregarded for purposes of the control requirement Example 10 The exchange is taxable to Paul, Mary, and Matt It does not qualify under § 351 because Matt is not a member of the group transferring property and Paul and Mary together received only 66 2/3% of the stock Thus, the control requirement is not met Example 11 a Ted is attempting to meet the control requirements of § 351 In order to qualify as a nontaxable exchange under § 351, the person or persons transferring property to a corporation for stock must own immediately after the transfer, stock possessing at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation Unless Peggy joins Ted in the transaction, he will not meet the control requirement and must recognize gain of $80,000 on the transfer © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Organization and Capital Structure b 4-9 A transferor’s interest cannot be counted if the stock received is of relatively small value in comparison to the value of that already owned and the primary purpose of the transfer is to qualify other transferors for § 351 treatment For advance ruling purposes, the IRS treats the amount transferred as not being relatively small in value if it is equal to, or in excess of, 10% of the fair market value of the stock already owned by that person Thus, if the one share of stock transferred to Peggy is less than 10% of the stock already owned by Peggy, Peggy’s interest probably is not counted Ted then is taxed on the transfer as he does not have an 80% interest in Robin Corporation pp 4-9 and 4-25 12 Pursuant to the general rule of § 357(a), the transfer of mortgaged property to a controlled corporation does not trigger gain Under this provision, the mortgage is not boot to the transferor shareholder However, there are two exceptions to the general rule of § 357 (a) Section 357(b) provides that if the principal purpose of the assumption of the liabilities is to avoid tax or if there is not a bona fide business purpose behind the exchange, the liabilities are treated as boot Further, § 357(c) provides that if the sum of the liabilities assumed exceeds the adjusted basis of the properties transferred, the excess is taxable gain pp 4-9 to 4-11 13 Libbie would probably not be taxed as to the liabilities assumed by the corporation Section 357(b) provides that if the principal purpose of the assumption of liabilities by the corporation is to avoid tax or if there is no bona fide business purpose behind the exchange, the liabilities are treated as money received and taxed as boot The bona fide business purpose requirement causes difficulty if the liability is taken out shortly before the property is transferred and the proceeds are utilized for personal purposes This is not the case here, since the mortgage proceeds are used to improve the property transferred to the corporation p 4-9 14 Section 357(c) requires the transferor of property to recognize gain if the corporation assumes liabilities in excess of the basis of the assets transferred Without this provision, a taxpayer would have a negative basis in the stock received Section 357(c) precludes the negative basis possibility by treating the excess over basis as gain to the transferor p 4-10 and Example 17 15 a If a shareholder transfers a liability to the corporation along with property, the basis in the stock received is reduced by the amount of the liability transferred to the corporation However, the transfer of the liability to the corporation will not produce gain to the transferor-shareholder (unless the liability exceeds the basis of the assets transferred or there was a tax avoidance scheme or no bona fide business purpose underlying the transfer) b In the event a shareholder transfers property with an aggregate adjusted basis in excess of its fair market value, the result reached in c below may need to be modified Section 362(e)(2) generally requires the corporation to step down the carryover basis for the property by the amount of the net built-in loss However, if the shareholder and the corporation elect, the basis reduction can be applied instead against the shareholder’s stock basis c The shareholder’s basis in the property transferred becomes the basis of the stock received, increased by the amount of gain recognized to the shareholder and decreased by the fair market value of boot received and the amount of liabilities transferred to the corporation d If a shareholder receives ‘‘other property” (boot) in addition to stock in a § 351 transfer, gain is recognized to the shareholder to the extent of the lesser of the gain realized or the fair market value of the boot received Section 358(a) provides that the © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 4-10 2012 Corporations Volume/Solutions Manual basis of stock received is the same as the basis the shareholder had in the property transferred, increased by any gain recognized on the exchange and decreased by boot received Figure 4.1 16 If the services performed constitute an ordinary and necessary business expense (e.g., the shareholder serves as the office manager), the corporation may deduct the value of the stock issued Otherwise, the cost must be capitalized For example, accounting or legal services provided by a shareholder in organizing the corporation must be capitalized Compare Examples 24 and 25 17 Goose Corporation’s holding period in the property includes Pedro’s holding period, regardless of the character of the property in Pedro’s hands In determining the holding period of Pedro’s stock, its holding period includes the holding period of the property transferred to Goose if it was either a capital or § 1231 asset in Pedro’s hands In this case, the holding period of the property is ‘‘tacked on’’ to that of the stock If any other type of property is transferred to Goose, Pedro’s holding period for the stock begins on the day after the exchange p 4-16 18 The basis rules are not the same for property acquired from a shareholder and for property acquired from a nonshareholder The basis of property received by a corporation from a shareholder as a capital contribution generally is the basis in the hands of the shareholder although it is subject to a downward adjustment when loss property is contributed The basis of property transferred to a corporation by a nonshareholder as a contribution to capital is zero pp 4-16 and 4-17 19 The advantages of utilizing debt are numerous Interest on debt is deductible by the corporation, while dividend payments are not Further, the shareholders are not taxed on the receipt of loan repayments unless they exceed basis With respect to equity, as long as a corporation has earnings and profits it is difficult to withdraw the investment without triggering dividend income However, since 2003, individual investors may prefer dividend income to interest income Dividend income is taxed using preferential capital gains rates while interest income is taxed as ordinary income pp 4-18 and 4-19 20 a If a loan is on open account, it is more easily characterized as a contribution to capital than if evidenced by a note b If a loan is payable on demand (i.e., it does not have a definite maturity date), it appears more like a contribution to capital c If a corporation has not made timely payments on a loan with a definite maturity date, it carries the attributes of a contribution to capital An individual’s failure to insist upon timely repayment (or satisfactory renegotiation) indicates that the repayment terms extend beyond the stated maturity date d If repayments are contingent upon earnings, the likelihood is a contribution to capital e When debt and equity obligations are held in the same proportion, the debt is more likely to be classified as equity Further, funds used to acquire the business’s operating assets are generally obtained through equity investments f Thin capitalization occurs when there is a high proportion of shareholder debt relative to shareholder equity Whether a shareholder debt to shareholder equity ratio of 5:1 is © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Organization and Capital Structure 4-11 excessive depends on the facts of the particular situation In certain cases, courts have held a debt-equity ratio of approximately this proportion not to be excessive pp 4-19 and 4-20 21 If § 1244 does not apply, worthless stock held as an investment produces a capital loss as of the last day of the taxable year in which the stock becomes worthless The burden of proving complete worthlessness is on the taxpayer claiming the loss No deduction is allowed for a mere decline in value However, if stock is not a capital asset (e.g., stock held for resale by a broker), worthlessness produces ordinary loss pp 4-20 and 4-21 22 If a shareholder lends money to a corporation in his or her capacity as an investor, any resulting bad debt generally is classified as nonbusiness However, if the loan is made in some capacity that qualifies as a trade or business, the shareholder-creditor can incur a business bad debt Employee status is a trade or business, and a loss on a loan made to protect the shareholder’s position as an employee qualifies for business bad debt treatment Shareholders also may receive business bad debt treatment if they are in the trade or business of lending money or of buying, promoting, and selling corporations The “dominant” or “primary” motive for making the loan controls the classification of the loss pp 4-21 and 4-22 23 a No deduction is allowed for a mere decline in value of property A deduction may be taken as a loss from the sale or exchange of a capital asset on the last day of the taxable year in which stock becomes completely worthless [§ 165(g)(1)] Here the stock is not completely worthless b No deduction is permitted for a loss on a sale of property to a related party under § 267(a)(1) For this purpose, however, Nelson’s aunt is not considered to be a related party See §§ 267(b)(1) and (c)(4) Therefore, Nelson may deduct a loss in this case, since it is like a sale to any other unrelated third party Loss is established through a sale or exchange c Nelson may deduct an ordinary loss only if the stock is not a capital asset or if it is § 1244 stock If Nelson was a broker and the stock was held for resale to his customers, he would have an ordinary loss Normally, however, stock is held as investment property and is a capital asset In that case, the loss would be a capital loss unless § 1244 applies d No deduction is permitted for a loss on a sale of property to a related party § 267(a)(1) e Nelson may deduct a loss on a sale to a third party Loss is established through a sale or exchange pp 4-20 and 4-21 24 Keith is attempting to enjoy the benefits of gain deferral and, at the same time, avoid the loss deferral aspects of § 351 In selling the loss assets for cash, instead of exchanging them for stock, a taxable event results, and losses can be recognized However, the plan probably will not succeed Because the sale is so close in time to the formation of the corporation, the IRS would collapse the sale and take the approach that the transfer of the loss assets also falls under Đ 351 â 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 4-12 2012 Corporations Volume/Solutions Manual But even if the sale could be disassociated from § 351, the loss disallowance rules of § 267 would apply to disallow the loss Section 267 disallows a loss deduction for exchanges between a shareholder and a corporation in which the shareholder owns more than 50% in value of the stock pp 4-24 and 4-25 25 Leasing some property to a controlled corporation may be a more attractive alternative than transferring ownership Leasing provides the taxpayer with the opportunity of withdrawing money from the corporation without the payment being characterized as a dividend If the property is donated to a family member in a lower tax bracket, the lease income can be shifted as well If the depreciation and other deductions available in connection with the property are in excess of the lease income, the taxpayer would retain the property until the income exceeds the deductions p 4-26 PROBLEMS 26 a $7,000 ordinary gain b $30,000 [$30,000 (basis of inventory) + $7,000 (gain recognized) – $7,000 (boot received)] c $37,000 [$30,000 (basis of inventory) + $7,000 (gain recognized)] d John recognizes gain of $9,000 (the amount of cash received) The gain is ordinary income because of the § 1245 depreciation recapture provisions e John has a basis of $55,000 in the Pine Corporation stock, computed as follows: $55,000 (basis in the equipment) + $9,000 (gain recognized) – $9,000 (boot received) f Pine Corporation has a basis of $64,000 in the equipment, computed as follows: $55,000 (basis of the equipment to John) + $9,000 (gain recognized by John) g Lucy has no recognized gain or loss A secret process is property for purposes of § 351 h Lucy has a basis of $25,000 in the Pine Corporation stock i Pine Corporation has a basis of $25,000 in the secret process j Sylvia has no gain or loss on the transfer k Sylvia has a basis of $30,000 in the Pine Corporation stock pp 4-3 to 4-13 and Figures 4.1 and 4.2 27 a $0 b $180,000 c $140,000 d $0 e $264,000 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Organization and Capital Structure 4-13 f $120,000 (basis in the equipment) and $4,000 (basis in the patent) g The answers would not change There is no requirement that the transferors receive the same type of stock Further, both common stock and most preferred stock qualify as ‘‘stock.” However, if Gail received “nonqualified preferred stock,” her realized gain would be recognized because this type of preferred stock is treated as boot h The answers would not change There is no requirement that the transferors be individuals Example and Figures 4.1 and 4.2 28 a None of the three individuals will recognize gain The nonrecognition provisions of § 351 apply to all the exchanges Example b Clyde will recognize gain of $260,000 ($350,000 – $90,000) on the exchange Example c Clyde would be well advised to avoid having his transfer treated as a part of an integrated plan that also includes Jane’s and Jon’s transfers If his transfer is considered independent, not only will Jane and Jon be able to benefit from § 351 (i.e., realized gains would not be recognized), but Clyde’s loss of $140,000 ($350,000 – $490,000) is recognized p 4-6 29 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 March 29, 2011 Mr Michael Robertson 1635 Maple Street Syracuse, NY 13201 Dear Mr Robertson: This letter is in response to your question as to whether you must report gain on the transfer of property to Red Corporation Our conclusion is based on the facts as outlined in your March 11 letter Any change in facts may cause our conclusion to be inaccurate The property you transferred had a tax basis of $200,000 and a fair market value of $850,000 for which you received stock representing a 75% interest in Red Corporation The other 25% interest is owned by Sarah Mitchell, who acquired her shares several years ago Because the stock you acquired represents less than an 80% interest in Red Corporation, you must report gain on the transfer Your gain will be $650,000 [$850,000 (value of the stock received) – $200,000 (your tax basis in the property transferred)] Should you need more information or need to clarify our conclusion, not hesitate to contact me Sincerely, Martha R Harris, CPA Partner © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 4-14 2012 Corporations Volume/Solutions Manual TAX FILE MEMORANDUM March 18, 2011 FROM: Martha R Harris SUBJECT: Michael Robertson Today I talked to Michael Robertson with respect to his transfer of appreciated property to Red Corporation for which he obtained only a 75% stock interest The remaining 25% interest was held by Sarah Mitchell, who acquired her interest several years ago At issue: Must a shareholder recognize gain on the transfer of appreciated property to an existing corporation if the shareholder has less than an 80% control of the transferee corporation after the transfer? Conclusion: Yes To qualify as a nontaxable transaction under § 351, the transferor must be in control of the transferee corporation immediately after the exchange Control means that the person or persons transferring the property must have an 80% stock ownership in the transferee corporation The transferor shareholder must own stock possessing at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock Control can apply to a single person or to several individuals if they are parties to an integrated transaction In this case, Sarah acquired her interest in the corporation several years ago; thus, she would not be part of the transaction involving Michael Because Michael obtained only a 75% interest in Red Corporation, the transfer is a taxable exchange Michael must recognize gain measured by the excess of the fair market value of the stock received over the tax basis of the property he transferred Therefore, the gain he recognizes is $650,000 ($850,000 – $200,000) pp 4-6 and 4-9 30 • Were Barbara’s and Alice’s transfers part of an integrated transaction? • Was there an agreement between Barbara and Alice regarding the transfers? • Because Alice is Barbara’s daughter, can her stock be attributed to Barbara in computing her stock ownership? p 4-6 31 The general rule under § 351 also applies to transfers to an existing corporation In this situation, Jaime has a taxable gain of $510,000 ($600,000 – $90,000) The exchange will not qualify under § 351 because Jaime does not have 80% control immediately following the transfer Jaime has a basis of $600,000 in the stock, and Hummingbird Corporation has a basis of $600,000 in the property Example 13 32 a Ann does not recognize a gain Bob recognizes ordinary income of $15,000, the value of the services he rendered to the corporation Bob does not recognize gain on the transfer of property to the corporation Examples and 12 b Ann has a basis of $150,000 in her stock, while Bob has a basis of $45,000 in his stock [$30,000 (basis in property transferred) + $15,000 (income recognized)] Figure 4.1 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Organization and Capital Structure c 4-15 Robin Corporation has a basis of $150,000 in the property Ann transferred and a basis of $30,000 in property Bob transferred Robin Corporation capitalizes $15,000 as organizational expenditures Figure 4.2 and Example 25 33 To be a member of the control group and aid in qualifying all transferors under the 80% test, a person contributing services must transfer property having more than a relatively small value in relation to the services performed Stock issued for property of relatively small value compared with the value of the stock to be received for services rendered by the person transferring such property will not be treated as issued in return for property The value of property transferred by Bob is less than 10% of the value of the services he provided Bob will probably not qualify as a member of the control group If Bob does not qualify as a member of the control group, Ann’s transfer will also not qualify as she transferred property for only 70% of the stock Therefore, both Ann and Bob would recognize gain/income on the exchanges Robin’s basis in the property transferred by Ann and Bob will be $420,000 and $15,000, respectively Examples 10 and 11 34 In addition to her cash salary of $30,000, Kim has ordinary income of $10,000 [10 (shares of stock in Azure Corporation) × $1,000 (value of each share)] Azure Corporation has a § 162 deduction totaling $40,000 ($30,000 cash + $10,000 stock) Example 24 35 a The transaction is fully taxable because Rhonda, the sole transferor of property, does not have control immediately after the transaction Therefore, all of the realized gain is recognized Amount realized—stock Less: Adjusted basis of property transferred Realized gain $200,000 (15,000) $185,000 Recognized gain $185,000 Example 13 36 b With the change, Rhonda is trying to avoid recognizing the $185,000 gain The plan involves Rachel becoming a transferor of property along with Rhonda so that together they would meet the 80% control test However, this plan will not be successful as Rachel’s interest cannot be counted—the value of the stock she would receive is relatively small compared to the value of the stock she already owns In addition, Rachel’s contribution would be made primarily to qualify Rhonda for § 351 treatment p 4-28 c The following alternatives would enable Rhonda to avoid gain recognition: • Rhonda can transfer property that has not appreciated in value For example, if she were to contribute $200,000 of cash to Peach, Rhonda would not recognize gain on the transaction • Rachel could contribute property of an amount that is not small relative to the value of the stock already owned By doing so, she would be considered a transferor of property along with Rhonda, and together, they would have control As a result, Rhonda would avoid gain recognition p 4-24 Natalie recognizes no gain on the transfer The problem concerns the application of § 357(c) since liabilities would exceed basis in the assets if the trade payables are considered Accounts payable of a cash basis taxpayer that give rise to a deduction when paid are not included as © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 4-16 2012 Corporations Volume/Solutions Manual liabilities for purposes of applying § 357(c) Consequently, the liabilities (notes payable of $360,000) not exceed the basis of the assets transferred ($450,000) Natalie has a basis of $90,000 in the stock in Brown Corporation [$450,000 (basis in the assets transferred to Brown Corporation) – $360,000 (liabilities assumed by Brown Corporation)] Brown Corporation has a basis of $450,000 in the assets received from Natalie pp 4-10, 4-11, and Figures 4.1 and 4.2 37 • Did the exchange four years ago qualify as a nontaxable exchange under Đ 1031? What basis did Gene acquire in the land? • What basis will Gene have in the Bronze Corporation stock? • Does Gene have control in Bronze? • How are the mortgages on the land treated for tax purposes? • Will the second mortgage be treated as boot under Đ 357(b)? What basis will Bronze Corporation have in the land? pp 4-2, 4-11, and 4-12 38 Because the two liabilities on the land exceed its basis, § 357(c) triggers gain of $50,000 to David [$250,000 (liabilities) – $200,000 (basis)] However, since $100,000 of the borrowed funds were used personally by David and the debt was assumed by the corporation, § 357(b) causes all the liabilities to be boot As § 357(b) predominates when both § 357(b) and § 357(c) apply, David recognizes gain on the transfer of $250,000 and his basis in the White Corporation stock is $200,000 [$200,000 (basis in the land) – $250,000 (liabilities assumed by White Corporation) + $250,000 (gain recognized)] White Corporation has no gain or loss on the transfer and its basis in the land is $450,000 [$200,000 (basis to David) + $250,000 (gain recognized)] pp 4-9 to 4-11 and Figures 4.1 and 4.2 39 a Michael’s transfer of property to Peach Corporation is subject to § 351 Therefore, the $30,000 realized loss ($260,000 – $290,000) is not recognized b Michael’s basis in the Peach stock is $290,000 Note that Michael’s basis exceeds the $260,000 value of his stock Thus, a $30,000 built-in loss exists with respect to his stock c Because the aggregate basis of the assets transferred to Peach exceeds their fair market value, the basis of the loss assets must be stepped down After the step down, the aggregate basis of the assets will equal their fair market value The basis of each of the assets is as follows: inventory, $60,000; delivery vehicles, $125,000; shelving, $75,000 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Organization and Capital Structure Assets Inventory Delivery vehicles Shelving Michael’s Adjusted Basis $ 60,000 150,000 80,000 $290,000 Unadjusted Tax Basis $ 60,000 150,000 80,000 $290,000 Assets Inventory Delivery vehicles Shelving *$50,000 $60,000 × **$10,000 $60,000 d $30,000 × $30,000 = FMV $ 90,000 100,000 70,000 $260,000 Adjustment $ –0– (25,000)* (5,000)** ($30,000) 4-17 Built-in Gain/(Loss) $30,000 (50,000) (10,000) ($30,000) Adjusted Tax Basis $ 60,000 125,000 75,000 $260,000 $25,000 = $5,000 If Michael plans to hold his stock for a substantial period of time, he and Peach may elect to allow Peach to take a carryover basis in the assets received If they so elect, Michael will reduce his stock basis to $260,000 [$290,000 (stock basis under § 358) – $30,000 (built-in loss)] To Peach’s advantage, its basis in the assets would be as follows: inventory, $60,000; delivery vehicles, $150,000; shelving $80,000 The election has no effect on the application of § 351 on the formation of Peach Examples 22 and 23 40 The $440,000 in liabilities of the proprietorship ($80,000 trade payables and $360,000 bank loan) exceed the $400,000 tax basis of the property transferred If all of the liabilities are included under § 357(c), Fay would have a taxable gain of $40,000 (the excess of the liabilities over her tax basis) However, the accounts payable of a cash basis taxpayer that give rise to a deduction are not considered to be liabilities for purposes of § 357(c) Thus, the $80,000 of trade payables are not included, liabilities not exceed basis, and no gain is recognized Fay has a basis of $40,000 in the stock in Robin Corporation [$400,000 (basis in the properties transferred to Robin Corporation) – $360,000 (bank loan assumed by the corporation)] Robin Corporation has a basis of $400,000 in the assets transferred to it by Fay p 4-10 and Figures 4.1 and 4.2 41 a Sara does not recognize gain on the transfer Jane has income of $15,000, the value of the services she renders to Wren Corporation b Wren Corporation has a basis of $25,000 in the property it acquires from Sara and a basis of $10,000 in the property it acquires from Jane It has a $15,000 business deduction under § 162 for the value of the services Jane renders Example 24 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 4-18 42 2012 Corporations Volume/Solutions Manual a Jane has income of $15,000 for the value of the services rendered b Wren Corporation has a basis of $10,000 in the property it acquires from Jane It must capitalize the $15,000 as an organizational expense Example 25 43 There are no tax consequences to Donna Donna has no recognized gain and no accelerated cost recovery to recapture when she transfers the machinery to Jay Corporation in exchange for stock Jay Corporation has a taxable gain of $65,000 on the sale of the machinery, all of which is ordinary income under § 1245 Jay has a basis of $30,000 in the machinery The recapture potential of the machinery carries over to the corporation; thus, Jay has to take into account the § 1245 recapture potential originating with Donna Example 26 44 a RetailMart Corporation does not recognize any income from the receipt of land, building, and cash The transfer is viewed as a capital contribution and not taxed pursuant to § 118 b RetailMart has a zero basis in the land and building c RetailMart Corporation must apply $800,000 of the cash received against the renovation costs, resulting in a zero basis in the building; $300,000 of the cash received is applied against the cost of the inventory, resulting in an inventory basis of zero d The $400,000 excess of the cash received reduces the basis of other property held by RetailMart The reduction is made in the following order: • Depreciable property • Property subject to amortization • Property subject to depletion • All remaining property pp 4-16, 4-17, and Example 28 45 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 June 6, 2011 Ms Emily Patrick 36 Paradise Road Northampton, MA 01060 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Organization and Capital Structure 4-19 Dear Ms Patrick: This letter deals with the tax treatment that applies following the bankruptcy of Teal Corporation this year Under the facts given, Teal Corporation was formed a number of years ago with an investment of $200,000 cash in return for which you received $20,000 in stock and $180,000 in 8% interest-bearing bonds maturing in nine years Later, you lent the corporation an additional $50,000 on open account During the corporation’s existence, you were paid an annual salary of $60,000 Because our conclusion is based on these facts, please inform us if our understanding is inaccurate If the stock was issued pursuant to § 1244 of the Internal Revenue Code, you have a $20,000 ordinary loss on the worthless stock Otherwise, the $20,000 investment in the stock results in capital loss treatment A danger exists that the IRS could argue thin capitalization and reclassify the long-term debt as equity This produces a capital loss on that portion of your investment Also, it could contend that both the long-term debt (regardless of whether it can be deemed hybrid stock) and the $50,000 open account are nonbusiness bad debts and, therefore, short-term capital losses If the IRS makes this assertion, we would recommend that you counter with the argument that the $50,000 open account is a business bad debt To this you need to show that the primary motive in lending the money to Teal Corporation was to protect your employment with the corporation Further, if you are in the business of lending money or of buying, promoting, and selling corporations, you might be able to deduct both the $180,000 and the $50,000 as business bad debts which are treated as ordinary losses As this is a complicated situation, please call us if we may provide further assistance Sincerely, Sarah Mitchell, CPA pp 4-18 to 4-23 and Example 29 46 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 November 14, 2011 Mr Steve Ferguson, President Jaybird Corporation 555 Industry Lane Pueblo, CO 81001 Dear Mr Ferguson: This letter is in response to your question with respect to the tax treatment of loans in the amount of $300,000 each from your shareholders, Vera, Wade, and Wes Our conclusion is based on the facts as outlined in your November letter Any changes in facts may cause our conclusion to be inaccurate The corporation seeks additional capital in the amount of $900,000 to construct a building Your equal shareholders, Vera, Wade, and Wes, propose to loan the corporation $300,000 each The corporation will issue to each a four-year note in the amount of $300,000 with interest payable annually at two points below the prime rate Jaybird’s current taxable income is $2 million © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 4-20 2012 Corporations Volume/Solutions Manual Payments on the notes would probably be treated as dividends for tax purposes The debt instruments have too many features of stock The debt will not bear a legitimate rate of interest and it is proportionate to the stock holdings of Vera, Wade, and Wes Because Jaybird has substantial current taxable income, the payment on the loans could indicate an attempt to withdraw earnings in the form of principal and interest payments on debt obligations rather than as dividend payments Should you need more information or need to clarify our conclusion, not hesitate to contact me Sincerely, Susan K Papenfuse, CPA Partner TAX FILE MEMORANDUM November 10, 2011 FROM: Susan K Papenfuse SUBJECT: Jaybird Corporation Today, I conferred with Steve Ferguson, President of Jaybird Corporation, with respect to his November 10 letter The corporation needs additional capital to construct a building in the amount of $900,000 The three equal shareholders of Jaybird Corporation, Vera, Wade, and Wes, each propose to loan Jaybird Corporation $300,000, taking from Jaybird a $300,000 four-year note with interest payable annually at two points below the prime rate Mr Ferguson informed me that Jaybird Corporation has current taxable income of $2 million At issue: Would the loans of $300,000 each by Jaybird’s shareholders represent debt or could the IRS successfully reclassify the debt as equity? Jaybird Corporation would want to deduct interest payments on the notes payable to its shareholders Thus, it would not want the debt reclassified as equity as all payments, including payments on the principal, would be treated as dividends The IRS has authority under § 385 to characterize corporate debt wholly as equity or as part debt and part equity Section 385 lists several factors that may be used to determine whether a debtor-creditor relationship or a shareholder-corporation relationship exists If the debt instrument does not bear a reasonable rate of interest, the debt is susceptible to reclassification as equity Further, if holdings of debt and stock are proportionate, the debt may be reclassified as equity When debt and equity obligations are held in the same proportion, shareholders are, apart from tax considerations, indifferent as to whether corporate distributions are in the form of interest or dividends When funds are loaned to finance capital asset acquisitions, the funds may also be reclassified as equity Funds used to acquire capital assets a corporation needs to operate are generally obtained through equity investments Conclusion: Should the shareholders of Jaybird Corporation loan it money in the form proposed, the IRS could probably successfully contend the debt was really an equity interest The loans present a problem because the debt is proportionate to the stock holdings of Vera, Wade, and Wes In addition, the interest rate is below the prime rate Jaybird Corporation will use the funds to construct a building This also indicates the debt is in reality an equity investment pp 4-18 to 4-20 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Corporations: Organization and Capital Structure 47 4-21 a Sam has an ordinary loss of $50,000 and a long-term capital loss of $40,000 Example 31 b Kara has a long-term capital loss of $40,000 Only the original holder of § 1244 stock qualifies for ordinary loss treatment p 4-23 48 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 July 28, 2011 Mr Mike Sanders 10 Hunt Wood Drive Hadley, PA 16130 Dear Mr Sanders: In response to your question with respect to stock you held in a corporation that qualified as a small business corporation under § 1244, our conclusion is based on the facts you provided us Any change in facts may cause our conclusion to be inaccurate Your brother, Paul, gave you the stock a few months after he purchased it for $40,000 three years ago You sold the stock this year for $25,000 You may deduct the difference between your basis and the selling price of the stock When property is given to another, there is a carryover of basis from the donor to the donee Thus, your basis in the stock is the $40,000 basis your brother, Paul, had in the stock Consequently, a long-term capital loss of $15,000 results from the sale of the stock Because you were not the original holder of the stock, the special rules of § 1244 not apply These rules would allow you to take an ordinary (rather than capital) loss deduction on the sale Should you need more information or need to clarify our conclusion, not hesitate to contact me Sincerely yours, Suzy Smith, CPA Partner TAX FILE MEMORANDUM July 19, 2011 FROM: Suzy Smith SUBJECT: Mike Sanders Today I talked to Mike Sanders with respect to his sale of stock which was issued to his brother, Paul, pursuant to § 1244 Paul paid $40,000 for the stock three years ago and gave the stock to his brother, Mike, a few months after he acquired it Mike sold the stock in the current tax year for $25,000 At issue: May a donee of stock in a corporation that qualified as a small business corporation under § 1244 take an ordinary loss deduction pursuant to § 1244? © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 4-22 2012 Corporations Volume/Solutions Manual Conclusion: No Only the original holder of § 1244 stock qualifies for ordinary loss treatment p 4-23 49 a The basis of the stock to Susan is $50,000 b The basis of the stock for purposes of § 1244 is only $25,000 c Susan would have a $30,000 loss ($20,000 – $50,000), only $5,000 of which would be ordinary under § 1244 The remaining $25,000 loss would be a capital loss Example 32 50 The shareholders of Purple Corporation have avoided pro rata holding of debt by having Mitch lease property to the corporation and receiving an annual rent that approximates the yield on the loans from Frank and Cora Because the loans are not pro rata, the IRS may have difficulty in reclassifying the debt as equity In addition, Purple Corporation can defend its debt-equity ratio by stressing the fair market value of its assets If the tax basis of Purple Corporation’s assets is used it is to [$300,000 (liabilities) to $50,000 (tax basis of assets)] However, if fair market value of its assets is used, the ratio is only to [$300,000 (liabilities) to $600,000 (value of assets)] Thus, Purple appears to have an acceptable debtequity ratio Examples 36 to 38 The answers to the Research Problems are incorporated into the Instructor’s Guide with Lecture Notes to accompany the 2012 Annual Edition of SOUTH-WESTERN FEDERAL TAXATION: CORPORATIONS, PARTNERSHIPS, ESTATES & TRUSTS © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ...To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 4-2 2012 Corporations Volume/Solutions Manual Question/ Problem Learning Objective... visit http://downloadslide.blogspot.com 4-8 2012 Corporations Volume/Solutions Manual c If a shareholder has only momentary control of the stock of the corporation after the transfer, these shares... or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 4-12 2012 Corporations Volume/Solutions Manual But even if the sale could be disassociated