2009_Solutions__002 - H Chapter Two H CORPORATE FORMATION...

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H Chapter Two H CORPORATE FORMATION AND CAPITAL STRUCTURE SOLUTIONS TO PROBLEM MATERIALS DISCUSSION QUESTIONS 2-1 Some of the tax-related issues that should be considered are: Double taxation. It is the responsibility of J’s adviser to ensure that J realizes that incorporation may cause the income earned by the boutique to be taxed twice, once at the corporate level and once again when it is distributed. Although the double tax is avoided whenever the corporation is able to make a deductible distribution (e.g., salary, rents, or interest), these opportunities may not always exist (e.g., J is already receiving a reasonable salary). Double taxation problems can also occur if appreciated property is transferred to the corporation or is acquired by the corporation. If appreciated property is distributed as a dividend or in liquidation, the corporation must recognize gain on the distribution, which in turn yields a corporate level tax. When this tax is coupled with the tax at the shareholder level, double taxation results. As demonstrated in the Chapter 5 discussion of liquidations (see tax planning section), this phenomenon exacts a large penalty when the owner of a closely held corporation decides to sell his or her business. This double tax penalty on the sale of a business is a severe disadvantage of the C corporation form. For this reason alone, owners of closely held businesses often elect to operate as an S corporation. Here, it is assumed that J has made the decision to incorporate as a C corporation, so attention to specific aspects of the incorporation process are examined below. Transfer of property. J should recognize that the tax law has important implications on the method employed by the corporation for obtaining use of business assets. Not all assets and liabilities currently associated with her boutique need to be transferred outright to the corporation in exchange for stock. Some of the assets could be retained and leased to the corporation (e.g., where the depreciation deduction would provide greater benefits to J than the corporation). Alternatively, some of the assets might be sold to the corporation. A different tax result occurs depending on which method is used. For example, the basis of the property that will be depreciated in future years may be altered, depending on the manner in which the property is obtained (e.g., if in exchange for stock, a carryover basis results, while a sale yields a step up in basis but at the cost of a tax). Exchange for stock or debt. Consideration should be given to whether the property should be contributed in exchange for stock and/or debt as well as other property. In this regard, it should be noted that the tax consequences differ dramatically if the corporation should not succeed (e.g., § 1244 stock yields ordinary loss, while a worthless security usually results in a capital loss).
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2009_Solutions__002 - H Chapter Two H CORPORATE FORMATION...

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