Chapter 2: Formation of the Corporation
Alice and Bill should consider forming a corporation and making an S election.
An S election will permit the losses
incurred during the first few years to be passed through to Alice and Bill and used to offset income from other sources.
form allows them to have limited liability.
Under the new check-the-box regulations, a noncorporate entity might elect to be taxed as
a corporation and then make an S election.
Such a possibility is unlikely to occur.
As an alternative to incorporating, Alice and Bill
might want to consider a limited liability company that is taxed as a partnership if their state laws provide for such an entity form.
C2-7 through C2-9.
The only default classification for the LLC is to be taxed as a proprietorship.
Because the LLC has only a single owner, it can
not be taxed as a partnership.
The entity can elect to be taxed as a C corporation or an S corporation.
If such an election is made,
Sec. 351 applies to the deemed corporate formation that occurs when the election is made to be taxed as a C or S corporation.
C2-7 through C2-9.
The IRS would initially look at the reason for incurring the liability (e.g., did the liability relate to the transferor's trade or
In addition, the IRS would be concerned with the length of time between when the liability was incurred and the transfer
If the liability was incurred in connection with the taxpayer's trade or business, then most likely there would be no Sec. 357(b)
problem even if it was incurred shortly before the transfer date.
Since Sec. 351 does not apply because 30% of the stock is issued for services, Ed must recognize $20,000
($35,000 - $15,000) of capital gain.
Ed's basis in his shares is $35,000 and his holding period begins on the day after the exchange date.
Fran recognizes a $10,000 ($35,000 - $45,000) Sec. 1231 loss.
Fran's basis in her shares is $35,000 and her holding period begins on the day after the exchange date.
George must recognize $30,000 of income.
George's basis in his shares is $30,000.
His holding period commences on the day after the exchange date.
Jet Corporation has a $35,000 basis in the land and a $35,000 basis in the machinery.
Its holding period for each
asset begins on the day after the exchange date.
The services, if capitalized, would have a $30,000 basis.
Since Sec. 351 would now apply to the exchange, the answers change as follows:
Ed does not recognize any gain or loss.
Ed's basis is $15,000.
His holding period begins in 1994.