Formation of a Corporation
Introduction
Generally speaking, the formation of a new company by one or more shareholders is a
nontaxable event. Under Section 351, any economic gain realized by a shareholder on the
exchange of property for stock in a “controlled” corporation is deferred until the shareholder
sells the stock. The shareholder takes a basis in the stock received from the corporation equal to
the tax basis of the property transferred to the corporation in exchange for that stock [IRC Sec.
358(a)(1)]. Presumably the value of the stock received will be equal to the value of the property
contributed, so that the shareholder will recognize the same amount of gain on sale of the stock
as he would have recognized had he sold the property rather than exchanging it for stock.
Example 1: Jacey owns restaurant property with a tax basis of $125,000 and a
fair market value of $300,000. She transfers the property a newly formed
corporation in exchange for 100 percent of the stock therein. Under Sec. 351, she
will not recognize any gain for tax purposes on formation of the corporation. She
will take a $125,000 tax basis in her corporate shares. Thus, the $175,000 gain
inherent in the restaurant property is “built” into her tax basis in the corporate
stock received, so that a subsequent sale of the stock for its $300,000 presumed
value will trigger recognition of a $175,000 capital gain.
The same rules apply where multiple investors pool their resources to form a new corporation.
So long as the shareholders as a group control the corporation immediately following the
exchange of property for stock, no gain or loss will be recognized by any of the shareholders.
They will each take a “substitute” basis in the shares received equal to the basis of the property
or properties transferred, thus allowing them to defer recognition of income until such time as
they dispose of their shares.
Section 362 imposes similar rules regarding the corporation’s tax basis in property received in
the transaction. The corporation takes a “carryover” basis in property received in a Section 351
exchange so that when it subsequently sells or disposes of such property it will recognize the
same amount of income or gain that the shareholder would have recognized had he or she sold
the property rather than contributing it to the corporation.
Example 2: Assume the same facts as in Example 1. The new corporation will
take a basis in the restaurant property received from Jacey equal to her $125,000
basis in such property. If the corporation subsequently sells the property for its
$300,000 value, it will recognize a $175,000 gain just as Jacey would have had
she sold the property outside the corporation. Transfer of the property to the
corporation does not allow the shareholder to avoid the tax consequences
associated with disposition of the property.
Note that while these rules prevent a taxpayer from forming a corporation to avoid paying tax on
the sale of appreciated property, they ultimately result in the double taxation of any gain realized
on the subsequent sale of property by a corporation. To illustrate, note that in the examples
1
above, sale by the corporation of the restaurant property contributed by Jacey will trigger
recognition of a $175,000 gain to the corporation. Assuming a 35% corporate tax rate, it will
owe $61,250 in corporate income taxes on the sale. After payment of taxes, it will have total
assets of $238,750 ($300,000 less $61,250 paid to the IRS). This is presumably the value of
Jacey’s stock. If she sells her stock for this value, she will recognize a taxable gain of $113,750
($238,750 less the $125,000 tax basis of her stock).
In the long run, formation of the corporation thus increases the total amount of taxes paid on
income or gain ultimately reported by the corporation. Shareholders must therefore exercise due
care in determining what properties to contribute to a newly formed corporation. The present
value of the increased tax burden may be minimal if the corporation is not likely to sell the
property for several years. It will not reach zero, however, so the corporate form of organization
is only appropriate when the benefits of incorporation exceed the additional tax costs.
There are significant benefits to incorporation. Most significant among these is easier access to
capital, and generally at lower cost. For smaller entities for which access to the capital markets is
not an immediate concern, incorporation can significantly reduce the legal risks of conducting
business operations. Because the corporation is treated as a person separate from its
shareholders, incorporation may protect assets owned by the shareholder outside the corporation
from the risks associated with those business activities conducted by the corporation. Similarly,
dividing the different components of the business into separate, but related, corporations may
allow the shareholders to shelter key assets from the risks associated with the activities of other
components of the overall business.
Example 3: Carey Johnson operates a multi-state trucking business. The business
is operated through a series of related corporations. One corporation owns the
buildings and equipment used by the headquarters and dispatch office. Another
owns the fleet of trucks leased to the parent corporation and used to transport
goods for customers. A third corporation hires the truck drivers and leases them to
the trucking company. By breaking the business apart in this way, the company is
able to protect its core assets (e.g., its fleet of trucks) from the risk that one of the
drivers employed by the employee leasing subsidiary may, for example, cause a
highway accident in which the occupants of another vehicle are harmed. In such a
case, if the damages are solely attributable to negligent behavior by the driver,
assets held by the truck leasing company and/or the parent company may be
protected from litigation risk.
This chapter summarizes the tax ramifications of forming a corporation. It explores in depth the
requirements and consequences of IRC Sec. 351—what are the shareholders’ tax bases in the
shares received, what is the corporation’s tax basis in properties received, how does the transfer
of liabilities to the corporation in connection with the contribution of property affect the
consequences to both parties, etc. The rules apply to the formation of any corporation, either by
an individual shareholder, a group of shareholders, a corporate parent forming a new subsidiary,
etc. The rules also apply whether or not the newly formed corporation is treated as a corporation
by other tax jurisdictions, whether states or foreign countries.
2
The focus of the discussion is on both an understanding of the rules imposed by the Internal
Revenue Code, and on how these rules impact the decision-making process for investors in a
newly formed company. In recent years, the economic significance of the double taxation of U.S.
corporate income has been lessened by the reduction of the individual tax rate on dividend
income received by shareholders to 15 percent (from a maximum of 38.5 percent prior to the
change). However, that tax rate reduction is not yet permanent and must be extended periodically
by Congress. If Congress fails to extend it at any point in the future, the consequences of double
taxation of corporate income will be that much more significant.
IRC § 351—Qualified Exchange of “Stock” for “Property”
Overview
Section 351(a) of the Internal Revenue Code (§351) reads as follows:
§ 351. Transfer to corporation controlled by transferor
(a) General rule
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.
Note that there are three key requirements for tax-free treatment under the statute:
(1) the shareholder(s) must contribute property;
(2) the shareholder(s) must receive only stock in exchange for such property; and
(3) the recipient corporation must be controlled by the contributing shareholder(s).
Property can consist of either tangible or intangible assets. Money also constitutes property. The
term “property,” however, does not include services, debt of the transferee corporation, or
accrued interest owed by the corporation to the shareholder [§351(d)].
Thus, where stock is issued in satisfaction of debt, or as compensation for services, the exchange
does not qualify for tax-free treatment under §351 and both the shareholder and the corporation
may be required to recognize income, gain, loss or deduction in connection with the exchange.
Example 4: Wilton Inc. borrowed money from Kevin Jackson. The loan required
Wilton to pay interest annually for ten years, with no principal payment until the
end of that ten year period, at which time the entire principal balance of the debt
comes due. Assume that at the end of the ten year period, Wilton offers to issue
stock in satisfaction of its debt to Jackson. Assume that the principal balance of
the debt is $1 million and that Wilton issues stock valued at $750,000 in
satisfaction of that balance. Wilton will recognize cancellation of indebtedness
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income of $250,000 on the exchange (and Jackson will be entitled to a $250,000
bad debt deduction).
Example 5: Ernest Flatkins has worked as a geologist for 25 years. This year, he
was offered a ten percent stock interest in a newly formed oil and gas exploration
company in exchange for his expertise in analyzing geologic data to determine the
most promising drilling locations in an offshore lease the company recently
acquired. The shares to be received by Ernest are valued at $1,200,000. If he
accepts the offer, he will recognize ordinary compensation income of $1.2 million
(and the corporation will be entitled to a deduction for compensation in the same
amount).
Where the shareholder contributes both property and services to the corporation in exchange for
stock, the value of the stock received must be allocated between the services and property
transferred. The portion of the stock attributable to the services provided by the shareholder will
fall outside the purview of §351 and will be fully taxable to the shareholder. However, the fact
that a portion of the shares are received for services will not prevent the application of §351 to
the remainder of the transaction (the exchange of stock for property).
Stock vs. Other Securities in the Corporation
The premise underlying §351 is that the investors in the corporation are merely pooling their
resources and are not changing the essential nature of their business activities. Where the
contributing shareholder receives only corporate stock in exchange for property contributed, her
investment in the property is subject to the continuing risk of conducting the business activities
of the corporation. In contrast, where the transferor receives cash or other property in exchange,
the shareholder has partially disposed of her original investment in the property and income must
be recognized accordingly.
Debt securities, such as bonds or notes payable, obviously do not qualify as stock. Nor do stock
rights or stock warrants [Reg. § 1.351-1(a)(1)]. The term “stock” includes all common shares,
whether voting or nonvoting, and most preferred shares. However, in cases in which the
preferred shares are redeemable (i.e., can be convertible into cash), or where the dividend rate on
the preferred shares varies with changes in interest rates or other economic indicators, the
preferred shares may be deemed nonqualified under §351(g).1 Preferred stock is nonqualified
(and therefore is not treated as stock) if possesses any of the following characteristics:
1. The preferred stock is redeemable upon demand by the “shareholder”;
2. The issuer or a related person is required to redeem or purchase the stock;
3. The issuer or a related person has the right to redeem or purchase the stock and, as of the
issue date, it is more likely than not that this right will be exercised; or
1
Under §351(g)(3)(A) preferred stock is stock that is limited and preferred as to dividends and does not entitle its holder to
meaningfully participate in corporate growth. The American Jobs Creation Act of 2004 (§899(a)) further provides that stock shall
not be treated as meaningfully participating in corporate growth unless there is a real and meaningful likelihood that returns to the
preferred shareholder will increase with corporate growth.
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4. The dividend rate of such stock varies in whole or in part (directly or indirectly) with
reference to interest rates, commodity prices, or other similar indices.
Under §351(g)(2)(C), redemption rights will not disqualify preferred shares if such rights or
obligations:
1. may be exercised only upon the death, disability, or mental incompetency of the holder; or
2. where the preferred shares were obtained in exchange for services provided, a right to
redemption will not disqualify the shares if such right can be exercised only upon the
holder's separation from service.
A convertibility feature under which the preferred shareholder can exchange her preferred shares
for common shares does not disqualify the preferred shares from being treated as stock under
§351.2
Receipt of Property Other than Stock
The general nonrecognition rule of §351(a) applies only where the shareholder transfers property
to a corporation “solely in exchange for stock.” Where the shareholder receives property other
than stock, commonly referred to as “boot” by tax practitioners, the entire transaction is not
disqualified. Rather, Section 351(b) provides:
b) Receipt of property.
If subsection (a) would apply to an exchange but for the fact that there is received, in
addition to the stock permitted to be received under subsection (a) , other property or
money, then—
(1) gain (if any) to such recipient shall be recognized, but not in excess of—
(A) the amount of money received, plus
(B) the fair market value of such other property received; and
(2) no loss to such recipient shall be recognized.
Thus, under §351(b), where a shareholder receives “boot” in addition to stock in the corporation,
she must recognize gain (but not loss) to the extent of the value of the boot received. Note that
the gain to be recognized by the shareholder under §351 will never exceed the amount of gain
that would have been recognized were §351 not applicable to the transaction. The gain realized
by the shareholder is equal to the excess of the value of the stock and other property received
over the basis of the property transferred to the corporation. Under §351(b), this gain (the
realized gain) is recognized to the extent of the value of the boot received by the shareholder
from the corporation.
2
Note that the difference between a redeemable share and a convertible share is that the former can be exchanged
for cash, while the latter is exchanged for common shares.
5
Example 6: J and D form new corporation JD, Inc. The two shareholders
contribute properties with tax bases and fair market values as follows:
Tax Basis
FMV
J
→
Property 1
$500,000
$800,000
D
→
Property 2
$300,000
$400,000
In exchange for their contributions, J and D each receive $400,000 worth of
shares in JD, Inc. J also receives a 10-year note receivable in the amount of
$400,000. Under §§351(a) and (b), D will recognize no gain or loss on the
exchange. She transferred Property 2 to JD, Inc. solely in exchange for $400,000
worth of JD, Inc. shares. D will take a $300,000 tax basis in those shares equal to
the basis of the property contributed by her to the company.
J, on the other hand, received both shares in JD, Inc. and a 10-year note receivable
from the corporation. The note receivable does not constitute stock and will be
treated as boot under §351(b). The tax basis of the property contributed by J was
$500,000. Its fair market value was $800,000. Thus, J realizes a $300,000
economic gain on the exchange ($800 value received less $500 tax basis in
property transferred). This realized gain must be recognized by J “to the extent”
of the value of the boot received. In this case, J received boot with a value of
$400,000 (assuming the note bears interest at market rates). She will recognize a
$300,000 gain, and will take a tax basis in her JD shares of $400,000. She will
also take a $400,000 tax basis in the note receivable. She would account for the
transaction as follows:
dr.
JD, Inc. shares
JD, Inc. note receivable
Property 1
Gain
cr.
$400,000
$400,000
$500,000
$300,000
Her gain will presumably be capital, unless depreciation recapture rules apply.
Under tax rates in effect for 2010, she would pay a capital gains tax of $45,000
(15%), assuming the gain was not offset by capital losses from the disposition of
other capital assets.
The same results would apply in the above example if J had received non-qualified preferred
stock, cash, or other tangible or intangible property from JD, Inc., rather than a debt instrument.
In many cases, a shareholder may transfer multiple assets to a newly formed corporation. If boot
is received in such a case, the amount of gain to be recognized under §351(b) is determined by
first allocating the boot received to the assets contributed on an individual asset-by-asset basis. In
6
Revenue Ruling 68-55,3 the IRS explains that this allocation is based on the relative fair market
values of the assets transferred. This allocation may affect both the amount and the character of
gain to be recognized by the shareholder.
Example 7: Individual A contributed the following four properties to newly
formed corporation Q, Inc:
Property 1
Property 2
Property 3
Property 4
Totals
Tax Basis
FMV
$ 500,000
$ 250,000
$ 750,000
$ 400,000
$1,900,000
$ 600,000
$ 500,000
$ 500,000
$ 400,000
$2,000,000
Assume that A received $1,000,000 of Q stock and a $1,000,000 five-year note
receivable from Q. The note receivable is boot for purposes of §351 and must be
allocated among the 4 properties contributed to the corporation by A. Allocating
the boot based on the relative fair market values of the properties will yield the
following allocation:
Property 1 (30%)
Property 2 (25%)
Property 3 (25%)
Property 4 (20%)
Totals
Boot
Allocation
$ 300,000
$ 250,000
$ 250,000
$ 200,000
$1,000,000
Recognized
Gain
$ 100,000
$ 250,000
$
0
$
0
$ 350,000
Note that no gain is recognized by A in connection with the boot allocable to
properties 3 and 4 because neither of these properties has appreciated in value
relative to A’s tax basis. In fact, property 3 is worth less than A paid for it. Since
no losses are recognized under §351(b), A’s realized loss on property 3 is ignored.
The net result is that A will recognize more gain on the exchange than she
realized in the aggregate with respect to the transfer of properties to Q, Inc., but
less gain than the amount of boot received in the exchange.
Ordinarily, the receipt of boot will trigger immediate gain recognition for the recipient
shareholder. However, when the boot takes the form of a promissory note as in examples 6 and 7
above, the shareholder can report the associated gain using the installment method under
§453(f)(6). Under the installment method, the gain is recognized as the note payments are
received. Thus, in example 7 above, shareholder A would recognize her gain ratably over 5 years
(presumably $70,000 per year, assuming that equal principal payments are received over the 5year period).
3
Rev. Rul. 68-55, 1968-1 CB 140.
7
The Control Requirement
The scope of §351 is not limited to the exchange of property for stock at formation of the
corporation. The statute applies to any transfer of property to a corporation in exchange for
stock, so long as the contributing shareholders, as a group, have “control” of the corporation
immediately after the exchange. “Control” is defined in §368(c) to mean the ownership of stock
possessing at least 80 percent of (1) the total combined voting power of all classes of stock
entitled to vote and (2) the total number of shares of all other classes of stock of the corporation.
The group of shareholders who must be in control of the corporation immediately following the
exchange includes only those shareholders contributing property as part of the same planned
transaction. The regulations under §351 make clear that where two or more shareholders
contribute property to a corporation, the transfers need not happen simultaneously so long as “the
rights of the parties have been previously defined and the execution of the agreement proceeds
with an expedition consistent with orderly procedure.” [Reg. §1.351-1(a)(1)] The Regs further
clarify that the shareholders included in this group may be individuals, trusts, estates,
partnerships, associations, companies, or other corporations.
All shares owned by a shareholder are counted in determining whether the contributing
shareholders have control, not just those received in connection with the current transfer of
property. Thus, a sole shareholder who contributes additional property to the corporation in
exchange for additional shares will qualify for tax-free treatment under §351 even if the
additional shares received in the exchange constitute less than 80 percent of the total shares
outstanding.
Shareholders receiving their shares in exchange for services are not included in the group for
purposes of determining whether the control requirements are satisfied. Where a shareholder
contributes both stock and services in exchange for stock, however, all shares received or
previously owned by such shareholder are counted for purposes of determining control. The only
exception to this provision applies where the property contributed by the shareholder is “of
relatively small value in comparison to the value of the stock and securities already owned (or to
be received for services)” and the primary purpose of the property transfer is to enable to broader
exchange to qualify for tax-free treatment under §351. [Reg. §1.351-1(a)(1)(ii)] It is acceptable
in this regard to ask the service provider to make a contribution of cash or property in order to
allow the overall transaction to qualify under §351, but the required contribution must be
meaningful in relation to the total amount of stock received.
Example 8: J, F and K agree to form a new corporation with the following
transfers of property:
Tax Basis
FMV
J
F
K
→
→
→
Property 1
Property 2
Services
$200,000
$300,000
0
8
$300,000
$450,000
$250,000
Assume that the shareholders receive shares in accordance with the relative values
of their individual contributions. Thus, J receives 30% of JFK stock, F receives
45%, and K receives 25%. Because K transferred no property to the corporation,
only shareholders J and F are included in the control group. Together, they own
only 75% of the outstanding shares, an amount that does not constitute control of
the corporation immediately following the above transaction. Accordingly, J will
recognize a taxable gain of $100,000 and F a taxable gain of $150,000 in
connection with the exchange. K will recognize ordinary income of $250,000.
Suppose the above arrangement was restructured so that K is allowed to purchase
shares at a discount in recognition of the value of the services rendered or to be
rendered to the corporation. Further assume that K is allowed to purchase
$250,000 worth of shares for $50,000. All three shareholders would now be
included in the control group, and they would own 100% of the company’s
outstanding shares collectively. J and F would now qualify for tax-free treatment
under §351 and would recognize no gain or loss. K would still not qualify for
§351 treatment with respect to the exchange of stock for services rendered and
would have to recognize ordinary income in an amount equal to the value of the
shares received for services (now $200,000).
Note that in the above example, K is contributing money to the corporation to protect J
and F from recognizing taxable income on the formation of the corporation. An
alternative scenario may involve J and F contributing additional property to push their
combined interests to 80 percent or more. This alternative would place the costs of
ensuring eligibility under §351 on J and F, who are receiving the benefits.
As noted, a shareholder receiving stock for services rendered must contribute a meaningful
amount of cash or property in order to be included in the group of contributing shareholders for
purposes of determining whether the corporation is a controlled corporation. Likewise, an
existing shareholder who joins in contributing property to an existing corporation in order to
allow a new shareholder to qualify under §351 must meet the same standard. In Revenue
Procedure 77-37,4 the Service has established a rule of thumb under which property transferred
to the corporation will not be considered to be of relatively small value “if the fair market value
of the property transferred is equal to, or in excess of, 10 percent of the fair market value of the
stock already owned (or to be received for services) by [the transferor shareholder].”
Example 9: Several years ago, P formed Pizza, Inc. to operate a regional chain of
pizza restaurants. The business has been very successful, and the restaurants have
developed a reputation for good pizza and fair prices. P was approached this year
by a restaurateur in another community who proposes that she and P join forces to
create a chain. P’s shares in Pizza, Inc. are currently valued at approximately $1
million. The new investor would contribute a chain of restaurant buildings and
equipment in a different region of the country in exchange for shares of stock in
Pizza Inc. Moreover, because her interest would be less than 80%, the proposal
would require P to also contribute additional capital to the corporation in order to
4
Rev. Proc. 77-37, 1977-2 CB 568, §3.07.
9
allow her to qualify for tax-exempt treatment under §351. If P contributes an
additional $100,000 to the corporation as part of the transaction, his contribution
would be treated as meaningful for purposes of §351 and the new investor would
be eligible to claim the benefits of §351 with respect to her contribution of
property to the company for additional shares.
Tax Basis of Shares and Other Property (“Boot”) Received by
Shareholder
Section 358(a)(1), which governs the measurement of the shareholder’s tax basis in shares
received in a §351 exchange, reads as follows:
§ 358. Basis to Distributees
(a) General rule
In the case of an exchange to which section 351, 354, 355, 356, or 361 applies—
(1) Nonrecognition property
The basis of the property permitted to be received under such section without the
recognition of gain or loss shall be the same as that of the property exchanged—
(A) decreased by—
(i) the fair market value of any other property (except money) received by the
taxpayer,
(ii) the amount of any money received by the taxpayer, and
(iii) the amount of loss to the taxpayer which was recognized on such exchange, and
(B) increased by—
(i) the amount which was treated as a dividend, and
(ii) the amount of gain to the taxpayer which was recognized on such exchange (not
including any portion of such gain which was treated as a dividend).
With respect to exchanges under §351, the “nonrecognition property” to which §358(a)(1) refers
is the stock received by the shareholder in exchange for property transferred to the corporation.
Because loss cannot be recognized by the shareholder in a §351 transaction, and no part of the
transaction is treated as a dividend, the basis of shares received by the shareholder is equal to the
tax basis of the property transferred to the corporation, less the fair value of any property or the
amount of any cash received by the shareholder in connection with the exchange plus gain (if
any) recognized by the shareholder. Where the shareholder receives more than one class of stock
(e.g., common and preferred shares), the aggregate tax basis of the shares received is calculated
10
as above. This basis is allocated between the different classes of stock received by reference to
the relative fair market values of the shares received.5
Example 10: E and F contributed the following properties to newly formed
Delphi Corporation:
E
F
→
→
Property 1
Property 2
Tax Basis
FMV
$150,000
$300,000
$300,000
$450,000
Because the values of the properties contributed by the two shareholders were not
equal, they will not receive an equivalent number of shares. E agrees that F should
receive more shares, but is reluctant to cede more than 50 percent of the voting
power to F. Accordingly, EF issues 10,000 shares of common stock and 1,000
shares of 5% cumulative nonvoting preferred stock. E and F each receive 5,000
shares of the common stock. All of the preferred shares are issued to F.
Based on the values of the properties contributed by each shareholder, the
common shares received by E are presumably worth $300,000. Since F received
the same number of common shares, those shares must also be worth $300,000.
Furthermore, since F contributed property with a fair market value of $450,000,
and received common shares worth $300,000, the value of the preferred shares is
presumably $150,000. E and F will take a tax basis in their shares as follows:
E
F
Common
Shares
Preferred
Shares
Total
$ 150,000
$ 200,000
0
$ 100,000
$ 150,000
$ 300,000
Note that while the common shares received by each shareholder have the same
fair market values, their tax bases differ. This is because the tax basis of the
shares is based on the tax basis of the property exchanged for those shares, rather
than on their fair market values.
With regard to boot received from the corporation, Section 358(a)(2) provides that the
shareholder takes a basis in any property received from the corporation other than stock equal to
its fair market value. This value may exceed the gain recognized by the shareholder. In such
cases, the shareholder’s tax basis in stock received will be less than the tax basis of the property
transferred to the corporation in exchange for such stock.
5
Reg. §1.358-2(b).
11
Example 11: Karen and Gary formed Hayes Corporation, transferring cash and
property as follows:
Karen →
Gary →
Cash
Property 1
Tax Basis
FMV
$250,000
$300,000
$250,000
$350,000
The corporation issued 10,000 shares of common stock each to Karen and Gary.
In addition, the corporation issued a five-year note payable in the amount of
$100,000 to Gary. The note pays interest at market rates, so that its fair market
value is equal to its face value. Karen recognizes no gain and takes a tax basis in
her stock equal to the amount paid for it—$250,000. Because Gary received
property other than stock (the note payable), he will recognize gain on the
exchange in an amount equal to the lesser of the value of the boot received
($100,000) or the gain realized on the exchange ($50,000). He will account for the
exchange as follows:
Stock
Note Receivable
Property 1
Gain
$250,000
$100,000
$300,000
$ 50,000
Under §358, Gary’s aggregate tax basis in the stock and property (note
receivable) received is equal to the tax basis of the property transferred to the
corporation ($300,000), plus the amount of gain recognized in connection with
the exchange ($50,000). His tax basis in the note receivable is equal to its fair
market value ($100,000), and the remainder of his tax basis is assigned to the
stock.
The holding period of the corporate stock received by the shareholder in a §351 exchange
ordinarily includes the holding period of the property transferred to the corporation. One
exception to this general rule is where the shareholder transferred ordinary income property
(such as inventory) to the corporation in exchange for some or all of his or her stock. The
holding period of any shares received for such property will not include the holding period of the
property. Where the shareholder transfers both ordinary income property and business-use or
capital assets to the corporation in exchange for stock, the holding period of each share received
must be bifurcated into a short-term and a long-term portion. The issue is not whether the
shareholder will recognize capital gain vs. ordinary income on sale of shares received in
exchange for inventory or other ordinary income property. Gain from the sale of shares of stock
received in a §351 exchange will always be characterized as capital gain. The only issue is
whether the gain will be short-term capital gain or long-term capital gain. Thus, the question of
the holding period of the stock will only be relevant if the shareholder sells some or all of his
shares within one year of the exchange.
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Sec. 357—Transfer of Liabilities to the Corporation
Special tax issues arise when property contributed to a corporation is encumbered by liabilities.
The assumption by the corporation of liabilities owed by the contributor-shareholder essentially
discharges the shareholder’s obligation to repay the creditor. Generally speaking, the discharge
of liabilities is treated as a cash payment for tax purposes. If that approach was followed under
§351, the discharge of liabilities would be treated as boot and would generate taxable income or
gain to the contributing shareholder. Fortunately, under §357, the corporation’s assumption of
liabilities is treated as boot solely for purposes of determining the shareholder’s tax basis in stock
received under §358. For purposes of determining gain under §351(b), liabilities are generally
ignored with two exceptions:
§357 Assumption of liability.
(a) General rule.
Except as provided in subsections (b) and (c), if—
(1) the taxpayer receives property which would be permitted to be received under section
351 or 361 without the recognition of gain if it were the sole consideration, and
(2) as part of the consideration, another party to the exchange assumes a liability of the
taxpayer,
then such assumption shall not be treated as money or other property, and shall not
prevent the exchange from being within the provisions of section 351 or 361 as the case
may be.
Two points should be emphasized here. First, the general rule clearly specifies that the
assumption by the corporation of liabilities is not treated as boot for purposes of §351. As
discussed previously, this rule does not apply for purposes of determining the shareholder’s tax
basis in stock received in the exchange (which is determined under §358, rather than §351).
Second, §357(b) and (c) carve out two exceptions to the general rule. The first exception
provides that the liabilities incurred in anticipation of transferring them to the corporation will be
treated as boot. The second exception provides that liabilities in excess of the basis of property
transferred to the corporation will be treated as boot.
Exception for “Anticipatory” Liabilities
Under §357(b), the assumption of liabilities by the corporation will be treated as boot if either of
the following is true:
1. The taxpayer appears to have incurred the liability with the intention of transferring it
to the corporation with a principal purpose of avoiding federal income tax on the
exchange; or
2. There is no apparent business purpose for the corporation to have assumed the
liability.
13
This exception is generally triggered in cases where the taxpayer used the contributed property as
collateral for a loan the proceeds of which were not invested into the property itself.6 In such
cases, unless the loan was incurred well before the taxpayer begin planning to form the
corporation, the transfer of the obligation to repay the debt to the corporation will likely be
treated as boot under §351(b). Where a portion of a liability transferred to a corporation triggers
this exception, the entire loan will be treated as boot, not just the portion that was not reinvested
in the property contributed to the corporation.7
Example 12: K owns an office building with a tax basis of $750,000 and a fair
market value of $1,800,000. At the beginning of the year, the building was
encumbered by a $250,000 mortgage the proceeds of which were used to finance
the original purchase of the building several years ago. This year, K borrowed
$800,000 from an unrelated lender, using the building as collateral for the loan.
She used $250,000 of the proceeds to pay off the outstanding balance of the first
mortgage. She used the remainder of the proceeds to purchase vacation property
for use by her and her family.
In August, 4 months after taking out the second mortgage on the building, K
transferred it to a newly formed corporation in exchange for stock. The
corporation assumed responsibility for the $800,000 second mortgage in
connection with the transfer. The exchange qualified for treatment under §351,
and K will recognize gain only to the extent that she received boot in the
transaction. The question is whether the $800,000 second mortgage constitutes
boot under §357(b). In this case, although K used a portion of the proceeds to pay
off the first mortgage, the remainder of the loan was invested in personal property
for the benefit of K and her family. Moreover, because the loan was incurred
shortly before K’s transfer of the office building to the new corporation, it
certainly appears that the loan was incurred in anticipation of transferring it to the
corporation and that the purpose was to avoid taxation. Accordingly, the entire
$800,000 loan transfer (and not just the $550,000 in excess of the amount used to
pay off the first mortgage) will likely be treated as boot under §357(b). Since K’s
realized gain ($1,800,000 less $750,000, or $1,050,000) exceeds the amount of
boot received, she will recognize $800,000 gain on the transfer of the building to
the corporation.
Exception for Excess Liabilities
The second exception to the general rule of §357(a) that debt does not constitute boot is triggered
when the amount of debt assumed by the corporation exceeds the aggregate tax basis of the
properties contributed to the corporation by the shareholder. Under §357(c), to the extent the
aggregate amount of liabilities assumed by the corporation exceeds the aggregate tax basis of
properties transferred to the corporation, the excess is treated as boot for purposes of §351(b).
6
7
For example, see F.W. Drybrough, 42 TC 1029 (09/14/1964).
See Estate of John G. Stoll, 38 TC 223 (05/09/1962).
14
This exception, which is triggered regardless of the taxpayer’s purpose in incurring the liabilities,
reflects the constraints of the accounting equation. Recall from the previous discussion that the
shareholder’s basis in stock received from the corporation is equal to the tax basis of property
contributed to the corporation, reduced by the amount of liabilities transferred to the corporation
(among other adjustments). Thus, the accounting equation would not balance if the shareholder
were not required to recognize gain in cases where the liabilities transferred exceed the basis of
the contributed property.
Example 13: Q transferred two tracts of real estate to a newly formed corporation
in exchange for 100 percent of the outstanding stock therein. The properties were
encumbered by liabilities in the amounts indicated below:
Property 1
Property 2
Tax Basis
FMV
Mortgage
$ 300,000
$ 100,000
$ 400,000
$ 500,000
$ 200,000
$ 250,000
The corporation assumes primary responsibility for repayment of the mortgages
on both properties. Although the liability encumbering Property 2 exceeds the tax
basis of that property by $150,000, the liability encumbering Property 1 is less
than the tax basis of that property. In the aggregate, the excess of the liabilities
($450,000) over the basis of the properties contributed to the corporation
($400,000) is only $50,000. Under §357(c), Q will be treated as having received
only $50,000 in boot, and will recognize gain in that amount under §351(b). She
would account for the exchange as follows:
Stock in new corporation
Mortgage, Property 1
Mortgage, Property 2
Property 1
Property 2
Gain
0
$200,000
$250,000
$300,000
$100,000
$ 50,000
Note that if Q did not recognize gain on the exchange, she would have to take a
negative basis in her stock in order for the accounting equation to balance. Since
negative basis is not allowed for tax purposes, recognition of gain is the only way
to balance the accounting equation.
The application of §357(c) cannot be avoided by having the shareholder guarantee
repayment of the debt by the corporation. Under §357(d), a liability is deemed to have
been transferred to the corporation when the corporation agrees to, and is expected to,
satisfy the liability, “whether or not the transferor has been relieved of such liability.”
Thus, the application of §357(c) can only be avoided by having the shareholder pay the
principal balance of the loan(s) down to the basis of the contributed property, or by
having the creditor(s) agree not to hold the corporation responsible for repayment of the
15
loan.8 In most cases, it will be less costly for the shareholder to pay the tax on the gain
than to pay down the principal balance of the loan.
Finally, §357(c)(3) provides that certain liabilities of a cash basis shareholder are ignored in
determining whether liabilities exceed the tax basis of property contributed to the corporation.
Under this exception, liabilities of a cash basis taxpayer that will be deductible when paid by the
transferee corporation are ignored when applying §357(c). Note that for accounting purposes, the
transferor shareholder has not yet accounted for such liabilities (or the shareholder would have
already claimed the associated tax deduction). Accordingly, the transferor shareholder has no tax
basis in the liability, and does not need to write the debt off his or her books. Since the liability is
ignored in accounting for the exchange of property for stock, gain does not need to be recognized
for the accounting equation to balance, and there is no need to trigger the provisions of §357(c).
Effect on Basis
Under §358(d), the assumption by the corporation of a shareholder’s liabilities in connection
with the transfer of property to the corporation is treated as a payment of cash to the shareholder.
As noted previously, this deemed cash payment is treated as boot only if it exceeds the basis of
the property contributed, or if it was incurred with the intention of transferring it to the
corporation and the proceeds were not invested in the contributed property.
For purposes of determining the shareholder’s tax basis in shares received in a §351 exchange,
however, the taxpayer must treat the entire liability transfer as a cash payment from the
corporation.9 As a result, it reduces the basis of shares received (though not below zero).
Example 14: L, T and D formed new LTD, Inc., transferring the following
properties and liabilities to the new company in exchange for LTD stock:
L → Property 1
T → Property 2
D → Property 3
Tax Basis
$200,000
$175,000
$600,000
FMV
$300,000
$450,000
$850,000
Debt
$ 50,000
$200,000
$350,000
L, T and D will have a tax basis in their LTD shares of $150,000, zero, and
$250,000, respectively, computed as follows:
L
T
D
Basis of property transferred
$200,000
$175,000
$600,000
Less: debt transferred to LTD
( 50,000)
(200,000)
(350,000)
Plus: gain recognized by s/h
0
25,000
0
Basis in LTD stock received
$150,000
0
$250,000
8
Alternatively, it may be possible for the shareholder to avoid triggering §357(c) by transferring a promissory note to the
corporation in an amount at least equivalent to the excess liability. See Peracchi v. Comm'r, 143 F3d 487 (9th Cir. 1998). In
contrast, see Revenue Ruling 68-629, 1968-2 CB 154, and Alderman v. Comm’r, 55 TC 662 (1971) in which the taxpayer was
deemed to have a zero basis in a personal note for purposes of applying §357(c).
9 Recall that liabilities are disregarded if they will generate a tax deduction to the corporation when paid.
16
Approaching the measurement of basis from another perspective, the accounting
entry for the shareholders would be as follows:
L:
Stock in LTD
Mortgage, Property 1
Property 1
Gain
T:
Stock in LTD
Mortgage, Property 1
Property 1
Gain
D:
Stock in LTD
Mortgage, Property 1
Property 1
Gain
$150,000
50,000
$200,000
0
0
200,000
$175,000
25,000
$250,000
350,000
$600,000
0
Note that the debits to “stock in LTD” reflect each shareholder’s tax basis in his
or her LTD stock.
Section 362—Determining the Corporation's Basis in Assets
Received
General Rule
The determination of the corporation’s tax basis in property received from the shareholder in a
§351 exchange is a very significant component of the U.S. corporate tax system. Under §362, the
corporation takes a carryover basis in such property, increased by the gain (if any) recognized by
the shareholder with respect to the exchange:
§ 362 Basis to corporations
(a) Property acquired by issuance of stock or as paid-in surplus
If property was acquired on or after June 22, 1954, by a corporation—
(1) in connection with a transaction to which section 351 (relating to transfer of property
to corporation controlled by transferor) applies, or
(2) as paid-in surplus or as a contribution to capital,
then the basis shall be the same as it would be in the hands of the transferor, increased in
the amount of gain recognized to the transferor on such transfer.
17
Note that the effect of this provision is that any gain that is not recognized by the shareholder
with respect to appreciated property transferred to the corporation will subsequently be subject to
two levels of taxation. Assume, for example, a case in which the shareholder transfers
appreciated property to the corporation and recognizes no gain under §351. Because the
corporation takes the shareholder’s tax basis in the property, it will recognize the same amount of
gain upon a subsequent disposition of the property as the shareholder would have recognized had
she sold the property rather than contributing it to the corporation. Moreover, because the
shareholder’s tax basis in the stock received from the corporation is equal to the tax basis of the
property contributed (in the situation where no gain is recognized under §351), she will
recognize the same amount of gain on a subsequent sale of the shares that she would have
recognized in connection with sale of the property. Thus, the appreciation inherent in the
property at the date of contribution to the corporation will now be taxed at both the shareholder
and corporate levels.
Example 15: Barney transferred real estate with a tax basis of $165,000 to newly
formed Bedrock Inc. in exchange for 100% of the shares of Bedrock. The fair
market value of the property was $300,000 and it was not encumbered by a
mortgage or any other liability. Under §358, Barney’s tax basis in his Bedrock
stock is $165,000; likewise, Bedrock’s basis in the real estate is $165,000.
Assume that Barney subsequently sells his Bedrock stock to Fred for $300,000.
He will recognize a taxable gain (capital) of $135,000. Assume further that
Bedrock subsequently sells the real estate received from Barney for $300,000. It
will also recognize a $135,000 gain. This is the same gain recognized by Barney
on the sale of his stock. It does not matter whether Barney’s sale of stock or the
corporation’s sale of the land occurs first. In either case, both will generate the
same amount of taxable gain—the gain became subject to two levels of tax at the
moment that Barney transferred the real estate to the corporation without
recognizing income or gain under §351. The double taxation that results cannot be
avoided except by Barney’s death, at which point his heirs will inherit his
Bedrock stock at fair market value under §1014.
Note that the assumption of liabilities by the corporation in connection with the §351 transaction
will not affect the computation of the corporation's basis in the transferred property unless the
transfer of liabilities triggers recognition of income to the shareholder via the application of
either §357(b) or (c).
Exception for Built-in Losses
While unrecognized gains inherent in property transferred to a corporation under §351 will be
subject to double taxation, the same is not true for unrecognized losses. Under §362(e), added by
the 2004 tax act, the corporation’s aggregate tax basis in property contributed by a shareholder in
a qualified §3351 transaction may not exceed the aggregate fair value of such property.10
Example 16: Cordell transferred the following properties to Wood Corp in a
qualified §351 transaction:
10
§362(e)(2)(A).
18
Property 1
Property 2
Tax Basis
FMV
Mortgage
$ 325,000
$ 250,000
$ 575,000
$ 150,000
$ 400,000
$ 550,000
$ 200,000
$ 250,000
$ 450,000
Cordell recognized no gain or loss on the exchange. His tax basis in his Wood
Corp. shares will be $125,000 ($575,000 basis in transferred property less
$450,000 liabilities assumed by the corporation). Under §362, Wood Corp’s tax
basis in the transferred properties would be $575,000. However, §362(e)(2)(A)
limits Wood’s basis in the properties to $550,000, their aggregate fair market
value.
Any reduction in basis under this provision is applied to those properties whose tax basis exceeds
their fair market value. In the above example, the $25,000 reduction in basis would be allocated
to property 1. Its tax basis in Wood Corp’s hand would be reduced to $300,000 ($325,000 less
$25,000 basis reduction). If more than one transferred property has a basis in excess of fair
market value, the basis reduction is allocated among the transferred properties in proportion to
their built-in losses immediately before the transaction.11
Example 17: Frank transferred the following properties to James Inc. in a
qualified §351 transaction:
Property 1
Property 2
Property 3
Tax Basis
FMV
Mortgage
$ 275,000
$ 500,000
$ 400,000
$1,175,000
$ 125,000
$ 600,000
$ 350,000
$1,075,000
$ 200,000
$ 250,000
$ 300,000
$ 750,000
Frank recognized no gain or loss on the exchange. His tax basis in his James Inc.
stock will be $425,000 ($1,175,000 basis in transferred property less $750,000
liabilities assumed by the corporation). Under §362(e)(2)(A) James Inc.’s
aggregate tax basis in the two properties is limited to $1,075,000, their aggregate
fair market value. The $100,000 reduction in basis ($1,175,000 less $1,075,000)
is allocated to properties 1 and 3, since those are the only properties with tax basis
in excess of fair market value.
The next requirement is to allocate the $100,000 basis reduction between
properties 1 and 2. In this case, the reduction is allocated 75% to property 1 and
25% to property 3, based on the relative built-in loss inherent in each:
Property 1
Property 3
11
Tax Basis
$ 275,000
$ 400,000
FMV
$ 125,000
$ 350,000
§362(e)(2)(B).
19
Difference
$ 150,000
$ 50,000
Relative Diff
75%
25%
Thus, James Inc.’s tax basis in property 1 will reduced by $75,000 (75% times the
$100,000 basis reduction) to $200,000. The corporation’s basis in property 3 will
be reduced by $25,000 to $375,000.
Election to Reduce Basis in Stock Instead
Rather than reducing the basis of transferred properties on the corporation’s balance sheet, the
shareholder may elect to reduce his or her tax basis in stock received from the corporation
instead.12 If the election is made, the shareholder’s tax basis in the shares received in the §351
exchange may not exceed their fair market value. The election is made by filing an affirmative
statement on both the shareholder’s and the corporation’s tax return for the year of the §351
exchange. The election is irrevocable.
When the tax rate applicable to the any gain subsequently recognized by the shareholder on sale
of the stock is lower than the tax rate applicable to the corporation, the election should reduce the
combined tax liability of the two entities. In such cases, the election would appear to be
advisable, although if other, unrelated, shareholders are involved in the corporation, the decision
may not be so easy.
Example 18: G and K transfer the following properties to Magma Corp in a
qualified §351 exchange:
G → Property 1
K → Property 2
Tax Basis
FMV
Mortgage
$ 475,000
$ 400,000
$ 875,000
$ 425,000
$ 500,000
$ 925,000
$ 300,000
$ 375,000
$ 675,000
Neither shareholder recognizes gain under §351. Under §358, their tax bases in
their shares are $175,000 and $25,000, respectively, computed as follows:
Basis of property transferred
Less: debt transferred to LTD
Plus: gain recognized by s/h
Basis in LTD stock received
G
$475,000
( 300,000)
0
$175,000
K
$400,000
(375,000)
0
$ 25,000
The corporation generally takes a carryover basis in the assets received from G
and K under §362. However, because the tax basis of property 1 exceeds its fair
market value, Magma’s basis in that property is limited to $425,000 under
§362(e)(2)(A). If G agrees to reduce her tax basis in her Magma shares to their
$125,000 value, Magma may take a $475,000 tax basis in Property 1. Ordinarily,
this would be an easy choice. Assuming G is an individual, any gain she
recognizes on a subsequent sale of her Magma stock will be taxed at 15%,
12
§362(e)(2)(C).
20
whereas the corporation’s marginal tax rate may be much higher. Moreover, any
loss she may recognize on sale of her Magma shares will be limited to her capital
gains from other transactions plus $3,000, meaning that she may not receive a tax
benefit for a large portion of her loss on the subsequent sale of her stock.
However, because G owns only half the shares in Magma, she may prefer to let
the corporation pay additional tax at some future date, preserving the built-in
capital loss inherent in her Magma shares.
Sec. 1032—No Gain Recognized by Corporation on Exchange
of Stock for Property
The issuance of stock by a corporation, like the issuance of a debt instrument, is a capital
transaction, and does not trigger the recognition of gain or loss to the corporation. This is true for
purposes of both financial and tax reporting. For tax purposes, §1032(a) specifies that the
corporation recognizes neither gain nor loss on the receipt of money or other property in
exchange for its own stock. Section 1032 applies to the corporation whether or not §351 applies
to the shareholder, so that a transaction that is fully taxable to the shareholder will generally not
trigger tax consequences to the corporation. Indeed, the scope of §1032 even extends to treasury
stock transactions in which a corporation repurchases its own stock from one or more
shareholders and subsequently reissues the repurchased shares at a price in excess of the amount
paid to repurchase them. The only exception to this rule applies when a corporation uses its own
stock to compensate another for the value of services rendered. In such cases, however, the
issuance of stock remains nontaxable to the corporation. Under §83, the corporation is treated as
having paid for services rendered with money, which the service provider subsequently
transferred back to the corporation for stock. The deemed money transaction generates a tax
deduction for the corporation (and income for the recipient), while the transfer of the
hypothetical funds back to the corporation for stock is nontaxable under §1032.13
Similar rules apply when shareholders or other taxpayers make contributions to the capital of the
corporation. Section 118 provides that gross income does not include amounts received by a
corporation as a contribution to capital. For example, where the shareholders of a corporation
make additional, pro rata contributions to corporate capital, it is not necessary for the corporation
to issue additional shares. The shareholders merely treat the transfers as an additional price paid
for their stock and increase their tax bases accordingly. Note that a contribution to capital does
not have to be pro rata for §118 to apply. Indeed, it need not even be received from a
shareholder. For example, if a local government or a local real estate developer, contributes land
to a corporation to encourage it to relocate, the receipt of the land will not be taxable to the
corporation, but will be excludable from income as a contribution to capital.
The above rule does not apply where the transfer is made by a customer or potential customer.14
For example, where a university paid a public utility to relocate overhead electric transmission
lines so the university could develop the property, the payment was taxable to the utility because
the university would, after completion of the development project, be a customer of the utility.15
13
Reg. §1.1032-1(a).
§118(b).
15 TAM 200450035.
14
21
Such payments are analogous to prepayments for services to be rendered, and are fully taxable to
the corporation upon receipt.
Section 188 also does not apply to situations in which a shareholder-creditor forgives a corporate
debt. In such cases, the transaction triggers forgiveness of indebtedness income under
§108(e)(6), unless the corporation is insolvent or the forgiveness income is otherwise excludable
under §108(a)(1).
The corporation’s tax basis in property received as a contribution to capital depends on whether
or not the transferor was a shareholder. If an existing shareholder makes an additional
contribution to capital and does not receive additional shares, the corporation will take a
carryover basis in the property received, increased by any gain recognized by the shareholder
(e.g., because contributed property was encumbered by liabilities in excess of basis). Under
§362(c)(1), however, the corporation takes a zero tax basis in any property received from a nonshareholder as a contribution to capital. For example, if a government entity contributes real
estate to a business as an inducement to get the business to relocate there, the corporation does
not recognize income on receipt of the real estate. Because it takes a zero basis in the realty,
however, it will recognize income in the future if it sells some or all of the realty.
Transfers to Investment Companies
IRC § 351(e)(1) specifies that tax-free treatment shall not apply to a transfer of property to an
investment company. The objective of this limitation is to preclude the use of a tax-free
incorporation to enable significant diversification of one's investment without any gain
recognition (i.e., shifting one's assets tax-free into a “swap fund”). The determination of whether
a company is an “investment company” is made by taking into account all of the stock and
securities held by the transferee company.
Reg. § 1.351-1(c)(1) states that for purposes of this provision, prohibited transfers are those that
(1) result, directly or indirectly, in diversification of the transferors' interest and (2) are made to a
regulated investment company (RIC), a real estate investment trust (REIT), or a corporation
more than 80 percent of whose assets (excluding cash and nonconvertible debt securities) are
held for investment and consist of readily marketable stock or securities or of interests in RICs or
REITs. Reg. § 1.351-1(c)(1) states that
1. diversification occurs if two or more persons transfer non-identical assets to the
corporation, unless these assets are an insignificant portion of the total value of the
transferred properties;
2. securities are held for investment unless they are dealer property or are used in a banking,
insurance, brokerage, or similar business; and
3. securities are readily marketable if (but only if) they are part of a class that is traded on a
securities exchange or traded or quoted regularly in the over-the-counter market.
Thus, if identical assets are transferred by several transferors no diversification occurs and
§351(e)(1) would not be applicable.
22
Transfers to a Foreign Controlled Corporation
If appreciated assets are transferred to a foreign corporation, §351 generally does not apply. IRC
§ 367(a) specifies that the corporation “shall not be considered as a corporation” unless certain
additional criteria are satisfied. The effect of this treatment is that the transferors must recognize
the gain realized on the transfer of appreciated property to the foreign corporation unless the
special criteria of IRC § 367(a) are satisfied. Only if the corporation satisfies these requirements
(primarily treating certain properties as sold to the transferee foreign corporation) will the
remaining portion of the transaction fall under the umbrella of IRC § 351 and, thereby, qualify
for tax-free treatment.
Inversion Transactions
IRC § 351 is sometimes used to implement an “inversion” transaction, particularly in the
domestic context. In the outbound (i.e., domestic to foreign) corporate restructuring context, the
format for converting to a foreign corporation has usually been a forward triangular merger or a
reverse triangular merger. Earlier, however, in Notice 94-43, 1994-2 CB 563 , the IRS noted that
certain tax benefits could also be achieved by transforming a domestic parent corporation into a
domestic subsidiary and the subsidiary into the domestic parent, under the anticipated protection
of IRC § 351 . Such inversion transactions typically involve a transfer of stock of a corporation
by one or more of its shareholders to a wholly or partially owned subsidiary of that corporation
in exchange for newly issued shares of stock of the subsidiary. The IRS indicated that, depending
on the facts and circumstances, an inversion transaction may improperly create losses or permit
the avoidance of income or gain in circumvention of the repeal of the General Utilities doctrine
or other applicable rules. The IRS indicated that further guidance would be forthcoming, but it
has yet to issue regulations in this area. See New York State Bar Association Tax Section,
“Report on Notice 94-93 and Rev. Proc. 94-76 ,” 95 TNT 31-26 (Jan. 31, 1995).
23