Tax 5015 Term Project Due Date: December 2, 9 PM

Tax 5015 Term Project due Date 9 Pm December 2 maximum Points 15

Maria and Mable are forming a corporation called Jazztime Inc., contribute property, and elect Subchapter S status. Each will receive 50 shares of the 100 authorized shares, with a total fair market value of $200,000. Maria contributes property valued at $100,000 with a tax basis of $60,000; Mable contributes property valued at $280,000 with a tax basis of $140,000, encumbered by a nonrecourse mortgage of $180,000, which the corporation assumes. The property was investment real estate owned by Mable for seven years.

Maria and Mable seek advice on the tax consequences of their contributions, including recognition of gains, basis calculations, and implications of the corporation’s projected first-year loss of $(80,000). They also request recommendations for year-end tax planning if losses are not fully deductible.

Paper For Above instruction

This memo provides an exhaustive analysis of the tax consequences related to the formation of Jazztime Inc. by Maria and Mable, focusing on the recognition of gains, basis calculations, debt assumptions, and the impact of the corporation’s initial losses on the shareholders. The analysis references pertinent provisions of the Internal Revenue Code (IRC), particularly IRC sections 351, 1366, and relevant regulations, which govern property transfers to corporations, shareholder’s basis in stock, and pass-through losses for S corporations.

1. Maria’s Recognized Gain

Under IRC section 351, a transfer of property to a corporation in exchange for stock does not typically result in gain recognition if certain conditions are met. However, gain must be recognized to the extent of money or the fair market value (FMV) of other property received or liabilities assumed by the corporation that exceeds the transferor’s basis in property (IRC section 351). Given that Maria contributes property with a FMV of $100,000 and a basis of $60,000, and assuming no liabilities are transferred or assumed by her, she will not recognize any gain, as her basis is less than FMV.

Since Maria's property has no liabilities transferred or assumed, and there is no receipt of boot, she recognizes no gain (IRC section 357). Thus, her recognized gain is zero, and her basis in her stock remains at her property basis, $60,000.

2. Maria’s Stock Basis

Maria’s basis in her Jazztime stock begins with her basis in the contributed property, adjusted for any liabilities assumed and gain recognition. Since she does not recognize any gain and does not assume liabilities, her basis in stock equals her property basis: $60,000.

3. Mable’s Recognized Gain

For Mable, the situation differs. She contributes property with a FMV of $280,000, a tax basis of $140,000, and encumbered by a nonrecourse mortgage of $180,000, which the corporation assumes. Under IRC section 357, the assumption of a liability by the corporation is generally ignored for gain recognition purposes unless the liability is transferred in a way that provides boot or excess liabilities. Here, the liability transferred ($180,000) is less than the FMV of Mable’s property ($280,000), so no gain is recognized at the time of contribution (IRC section 351). The transfer creates no recognition of gain or loss.

Mable’s basis in her stock is calculated as her property basis plus any gain recognized (none here) and increased by liabilities transferred. Her basis equals her property basis, $140,000, because the liability assumed ($180,000) exceeds her basis but does not generate gain recognition, and the basis must be increased by the liability transferred minus gain recognized, which in this case results in a basis of $140,000.

4. Mable’s Stock Basis

Mable’s basis in her stock equals her adjusted basis in the contributed property plus her share of liabilities assumed, resulting in a basis of $140,000 + ($180,000 liability transfer) - (gain recognized, which is zero). Thus, her basis remains at $140,000.

5. Corporation’s Basis in Contributed Property by Mable

The corporation’s tax basis in Mable’s contributed property equals the FMV, i.e., $280,000, in accordance with IRC section 362. The assumption of the nonrecourse mortgage secures the property and is treated as a transfer of liabilities, increasing basis accordingly. Therefore, the corporation’s basis in the property is $280,000, reflecting the FMV plus the liability assumed.

6. Treatment of Business Losses in the First Year

(a) Deductibility of Losses

For S corporation shareholders, losses are deductible to the extent of their stock basis plus any direct loans or contributions. Maria and Mable can deduct their shares of the $(80,000) loss based on their stock basis at year-end. Since Maria’s initial basis is $60,000 and Mable’s is $140,000, their maximum deductible share of the loss is limited accordingly.

Assuming losses are split proportionally, Maria can deduct her share up to her basis ($60,000), while Mable can deduct up to her basis ($140,000). The excess loss beyond basis can’t be deducted currently but can be carried forward.

(b) Year-End Stock Basis

Maria’s basis, initially $60,000, reduces by her share of loss ($60,000 or less), potentially reaching zero; any remaining loss cannot be deducted due to basis limitations. Mable’s basis starts at $140,000 and reduces proportionally by her share of loss, which could be up to her basis, possibly resulting in a reduction to zero if losses exceed her basis.

(c) Non-Deductible Losses

Losses exceeding basis are suspended and carried forward until additional basis is provided, such as through additional contributions or loans, which Mable and Maria might consider for future tax planning.

7. Year-End Tax Planning Recommendations

To maximize current deductions, Maria and Mable could consider additional capital contributions or loans to increase basis, allowing more of the losses to be deducted now. Alternatively, they might delay distributions or consider acquiring additional stock or debt in Jazztime to create basis for further loss deduction. Consulting with a tax professional to analyze specific opportunities, including timing of contributions and alternative structuring, would be prudent before year-end.

Conclusion

In summary, both Maria and Mable do not recognize gain upon their property contributions due to the protection offered by IRC section 351, provided the transfer conditions are met. Their stock basis reflects their respective original property bases, potentially reduced by the share of losses. The corporation’s basis in Mable’s property aligns with the FMV and liabilities assumed. The projected loss of $80,000 will be allocated proportionally, with deductions limited to basis. Strategic year-end planning could optimize their ability to deduct losses presently, ensuring fiscal efficiency and minimizing tax liabilities.

References

  • Internal Revenue Code (IRC) § 351. Transfer to Corporation Receiving Property
  • IRC § 1366. Deduction and Losses at the Shareholder Level
  • IRC § 357. Effect of Exchange
  • IRC § 362. Basis of Property Acquired by Purchase or Exchange
  • IRS Publication 541, Partnerships, LLCs, and S Corporations
  • Revs. Rul. 85-13, Property Contributions and Gain Recognition
  • Schroeder, K. (2021). Federal Income Taxation of S Corporations. Tax Law Review.
  • Schedler, N. (2020). Tax Planning Strategies for Pass-Through Entities. Journal of Taxation.
  • IRS Publication 542, Corporations
  • Vanderkam, P. (2019). Tax Aspects of Nonrecourse Debt. Journal of Accountancy.

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