Is The Formation Of Lakeside Inn Corp A Taxable Event

Is The Formation Of Lakeside Inn Corp A Taxable Event

1. Is the formation of Lakeside Inn Corp. a taxable event? 2. What are the tax consequences to the corporation and the 2 shareholders upon the formation of Lakeside Inn Corp.? a. Is the formation of the corporation a taxable transaction for the shareholders? b. What is the gain or loss realized by each shareholder? c. What is the gain or loss recognized by each shareholder? d. What is the basis of each shareholder in his corporation interest? e. What is the corporation's basis in the property transferred by the shareholders?

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The formation of a corporation, such as Lakeside Inn Corp., triggers a series of tax considerations that determine whether the transaction is taxable and how gains, losses, and bases are established. Generally, the creation of a corporation through the transfer of property by shareholders can be a tax-neutral event, but specific circumstances influence the tax consequences for both the corporation and the shareholders.

Taxability of the Formation of Lakeside Inn Corp.

In typical scenarios, the formation of a corporation through the transfer of property by shareholders to the corporation does not constitute a taxable event under Internal Revenue Code (IRC) Section 351. If the transferors (shareholders) control the corporation immediately after the transfer, and the transfer qualifies under IRC Section 351, then neither the corporation nor the shareholders recognize gain or loss upon formation. This provision is designed to facilitate business formation without immediate tax consequences, provided certain requirements are met.

Tax Consequences for the Shareholders

Under IRC Section 351, when the shareholders transfer property to the corporation in exchange for stock and control is retained immediately after the exchange, the transfer is generally non-taxable. This means that the shareholders do not recognize gain or loss at the time of transfer. However, this rule has exceptions, including situations where property has appreciated significantly, or liabilities assumed by the corporation exceed the basis of property transferred.

Gain or Loss Realized by Shareholders

The gain or loss realized by each shareholder is typically the difference between the fair market value (FMV) of the property transferred and the shareholder’s adjusted basis in that property. If, for example, a shareholder transfers property with an FMV exceeding their adjusted basis, they realize a gain equal to the difference; conversely, if the FMV is less than their basis, they realize a loss. Under IRC Section 351, such gains or losses are not recognized upon formation if the transfer qualifies for non-recognition.

Gain or Loss Recognized by Shareholders

In the formation of Lakeside Inn Corp., assuming the transaction qualifies under IRC Section 351, shareholders recognize no gain or loss at the formation. Recognition only occurs if the transfer does not qualify for non-recognition or if specific exceptions apply, such as the receipt of boot (non-stock property) or liabilities assumed exceeding basis.

Basis of Each Shareholder in His Corporation Interest

The basis of each shareholder's stock is generally equal to the basis of the transferred property, increased by any gain recognized, and decreased by any liabilities assumed by the corporation that are not considered liabilities they are personally responsible for. If no gain is recognized, the basis is simply the adjusted basis of the property transferred, subject to adjustments for liabilities transferred.

Corporation's Basis in Property Transferred

The corporation's basis in the property received is typically equal to the transferor’s basis immediately before the transfer, increased by any gain recognized (if any). This basis is crucial for depreciation, amortization, or gain/loss calculations upon subsequent sale or disposition.

Conclusion

In conclusion, the formation of Lakeside Inn Corp., involving the transfer of property from shareholders, is generally non-taxable under IRC Section 351 provided the control requirement is met. Shareholders do not recognize gains or losses at formation, but their basis in the stock reflects the basis of the transferred property plus any adjustments. The corporation’s basis in the property is also set equal to the transferor’s basis. These rules allow business owners to incorporate and transfer assets without immediate tax consequences, facilitating entrepreneurship and business expansion.

References

  • Internal Revenue Code § 351
  • Schroeder, R. G., Clark, M. C., & Vess, S. K. (2021). Fundamentals of Federal Income Taxation. Cengage Learning.
  • Walston, W. (2019). Federal Income Taxation of Corporations and Shareholders. Aspen Publishers.
  • Gleckman, M. (2020). Principles of Federal Income Taxation. Foundation Press.
  • Revsine, L., Collins, D., & Johnson, G. (2018). Financial Statement Analysis. Pearson.
  • Treffers, A. (2022). Corporate Taxation: Principles and Practice. Wolters Kluwer.
  • Summers, M. (2017). Business Formation and Entity Selection. The CPA Journal.
  • Miller, E. (2019). Tax Planning for Business Formation. Journal of Accountancy.
  • IRS Publication 542 (Corporations) (2022). Internal Revenue Service.
  • Clark, M., & Prewitt, S. (2018). Business Structures and Tax Considerations. Thomson Reuters.

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