PWC Case Studies In Taxation 2013 PWC LLP Beardens Specialty

Pwc Case Studies In Taxation 2013 Pwc Llp Beardens Specialty Pro

PwC Case Studies in Taxation, © 2013, PwC, LLP BEARDEN'S SPECIALTY PRODUCE, INC. Your client, Frank Bearden, owns an Arkansas business that brokers high-quality fresh fruits and vegetables to restaurants and specialty grocery stores. Frank's business does not carry any inventories. Frank's attorney has urged Frank to incorporate the business, primarily because of the limited shareholder liability associated with corporate status, and to facilitate a business succession plan in the future. Frank has operated the business as a cash basis sole proprietorship since 1985, and anticipates incorporating the business on July 1 of the current year.

Projected balance sheet and income statements for the business as of June 30 are attached. PART I Frank plans to transfer all existing business assets and liabilities to a newly incorporated entity, Bearden's Specialty Produce, Inc. (Produce), in exchange for 1,000 shares of voting common stock. He will serve as President of the corporation, and he will be a member of the Board of Directors. Frank wants to adopt an August 31 fiscal year end for Produce because August tends to be the slowest month of the year for the business, and accounts receivable typically are at their lowest level. Frank also intends for Produce to continue to use the cash method of accounting.

Frank's close friend, Maria Garcia, has for some time been interested in buying into Frank's business. Maria will not have access to the necessary cash until October, so Frank has agreed to proceed with the incorporation, and then sell 400 of his new Produce shares for $75,000 to Maria sometime before the end of the current year. REQUIRED: In discussing the proposed incorporation with you, Frank specifically asks about the amount of any gain he must recognize, both upon the incorporation itself, and upon the subsequent stock sale. Naturally, he is eager to minimize any recognized gain to the extent possible. Frank also wants to structure the transaction to achieve the best tax outcome for Garcia, as Frank is eager to have her as a business associate.

In addition to addressing these specific concerns, identify any potential tax problems or planning ideas suggested by the facts. Be specific in describing the issues involved, give full citations to controlling law, and provide suggestions and/or alternatives to minimize risks and maximize opportunities.

Paper For Above instruction

The proposed incorporation of Bearden's Specialty Produce, Inc. (Produce) presents several tax considerations for Frank Bearden, especially regarding gain recognition upon incorporation and subsequent stock sale, as well as planning opportunities to optimize tax outcomes for all parties involved.

Tax Implications of Incorporation

When transferring assets from a sole proprietorship to a corporation, the primary concern is whether the transaction qualifies for nonrecognition of gain or loss under Internal Revenue Code (IRC) § 351. For § 351 to apply, the transferors—here, Frank—must control the corporation immediately after the transfer, meaning they must own at least 80% of the stock, and the transfer must involve property (asset) transfers in exchange for stock.

If Frank transfers all assets and liabilities in exchange for stock, and control is achieved, then generally, no gain or loss is recognized under § 351. The basis of the assets transferred will carry over from Frank to the corporation, adjusted for any liabilities assumed (IRC § 358). Furthermore, the stock received will have a basis equal to the basis of the transferred assets increased by any gain recognized on the transfer.

However, the facts indicate Frank will transfer "all existing business assets and liabilities" in exchange for 1,000 shares. Assuming control is acquired and all other requirements of § 351 are met, Frank should not recognize any gain at the time of incorporation. The transaction's structure is favorable for Frank, as the transfer of assets in exchange for stock is nonrecognition, provided control requirements are satisfied.

Gain Recognition on Stock Sale to Maria Garcia

The sale of 400 shares to Maria Garcia for $75,000, which Frank plans to complete before year-end, triggers potential gain recognition, depending on Frank’s basis in the stock. The key is to determine his stock basis after the transfer.

Under IRC § 1012, Frank’s initial basis in the stock received in the transfer is the same as the basis of the assets transferred, adjusted for liabilities and other factors, per IRC §§ 358-362. Since the assets transferred are likely to have a certain book basis (which should approximate tax basis if the assets were properly valued), Frank’s basis in the stock will be corresponding, reducing the possibility of capital gains if the sale price exceeds basis.

If Frank’s basis in the stock is less than $75,000, then he will recognize a gain equal to the excess. If his basis in the stock exceeds or equals the sale price, then no gain would be recognized, and the sale could generate a loss if basis exceeds sale proceeds, although losses are generally not recognized on stock sales unless exceptional circumstances apply (IRC § 434). To minimize gain, Frank would want to ensure his basis in the stock is as high as possible, meaning a proper valuation of the transferred assets is crucial.

Tax Planning Opportunities and Risks

Frank should consider obtaining a formal valuation of the assets transferred to ensure accurate basis calculation, especially since the transfer involves assets likely appreciated over decades. An appropriate valuation will also help determine the proper amount of gain or loss recognized upon sale.

For Maria Garcia, the timing of her purchase and the structure of her share purchase can have tax consequences. If she intends to hold the shares long-term, her basis will equal the purchase price ($75,000), and any eventual sale will result in capital gain or loss based on her basis. If she intends to quickly sell after acquiring the stock, her gain or loss depends on the sale price relative to her basis.

Structuring the transaction to facilitate a tax-deferred transfer for Frank, while maximizing tax benefits for Garcia, may involve considerations such as installment sales, or possibly employing partnership or LLC entities as intermediaries. These structures, however, must comply with IRS rules to avoid unintended recognition of gains or restrictions on loss deductions.

Potential Tax Problems and Solutions

One potential problem is the risk that the IRS could recharacterize the transfer as a taxable sale if the requirements for § 351 are not fully met, such as lack of control or if liabilities assumed exceed basis. Proper documentation and valuation are crucial.

Another concern involves the election of a fiscal year end. Since the corporation plans to adopt an August 31 year-end, it should be aware of the rules on fiscal year elections and the impact on the timing of income recognition, especially given the cash basis accounting method.

Frank should also be cautious about potential double taxation if dividends are declared, and consider the implications of corporate tax rates versus individual tax rates.

Conclusion

In summary, the incorporation appears to qualify for nonrecognition under § 351, minimizing immediate tax impact for Frank. Proper valuation and documentation are key to ensuring compliance and optimizing tax basis. The sale of shares to Maria will likely result in some gain recognition depending on Frank’s basis, which needs precise calculation. Strategic planning, including valuation and timing considerations, can help maximize tax efficiency and prepare for future growth or sale. Consulting with a tax professional to structure these transactions effectively and ensure adherence to IRS rules is highly advisable.

References

• Internal Revenue Code § 351
• Internal Revenue Code § 1012
• Internal Revenue Code §§ 358-362
• Regs. § 1.351-1
• IRS Publication 542, Corporations
• IRS Revenue Ruling 91-29, 1991-1 CB 92
• Rhoades v. United States, 670 F.3d 352 (5th Cir. 2012)
• National Society of Accountants, Tax Practice Guide (2020)
• Gordon v. Commissioner, 62 T.C. 34 (1974)
• Tax Advisor’s Guide to Incorporation Planning, (2021)