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Exam 18: Corporations: Organization and Capital Structure

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Question 1

True/False

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A shareholder lends money to his corporation in his capacity as an investor.If the loans become worthless, a business bad debt results.

A) True
B) False

Correct Answer

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False

Question 2

Multiple Choice

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Tom and George form Swan Corporation with the following investments: Tom transfers machinery worth $100,000 (basis of $40,000) , while George transfers land worth $90,000 (basis of $20,000) and services rendered in organizing the corporation worth $10,000.Each is issued 25 shares in Swan Corporation.With respect to the transfers:

A) Tom has no recognized gain; George recognizes gain/income of $80,000.
B) Neither Tom nor George recognizes gain or income.
C) Swan Corporation has a basis of $30,000 in the land.
D) George has a basis of $30,000 in the shares of Swan Corporation.
E) None of the above.

F) B) and C)
G) B) and D)

Correct Answer

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D

Question 3

Multiple Choice

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Rachel owns 100% of the stock of Cardinal Corporation.In the current year Rachel transfers an installment obligation, tax basis of $180,000 and fair market value of $350,000, for additional stock in Cardinal worth $350,000.

Rob and Fran form Bluebird Corporation with the following investments. Each receives 50% of Bluebird's stock.In addition, Fran receives cash of $40,000.One result of these transfers is that Fran has a:

For transfers falling under § 351, what are the holding period rules for stock received by the shareholder and for the assets transferred to the corporation?

In order to induce Yellow Corporation to build a new manufacturing facility in Knoxville, Tennessee, the city donates land (fair market value of $400,000) and cash of $100,000 to the corporation. Several months after the donation, Yellow Corporation spends $450,000 (which includes the $100,000 received from Knoxville) on the construction of a new plant located on the donated land.

Nick exchanges property (basis of $100,000; fair market value of $3 million), for 65% of the stock of Yellow Corporation. The other 35% of the stock is owned by Gloria who acquired it several years ago. What are the tax consequences to Nick?

Linda formed Pink Corporation with an investment of $200,000 cash, for which she received $20,000 in stock and $180,000 in 5% interest-bearing bonds maturing in ten years.A few years later Linda loaned Pink an additional $40,000 on open account.Pink becomes insolvent in the current year and is adjudged bankrupt.Linda was the president of Pink Corporation and was paid an annual salary of $35,000 for the past three years.Linda has no other employment.How will Linda treat her losses for tax purposes?

Perry organized Cardinal Corporation 10 years ago by contributing property worth $2 million (basis of $450,000) for 2,500 shares of stock in Cardinal, representing 100% of the stock in the corporation.Perry later gave each of his children, Brittany and Julie, 750 shares of stock in Cardinal Corporation.In the current year, Perry transfers property worth $600,000 (basis of $150,000) to Cardinal for 1,000 shares in the corporation.What gain, if any, will Perry recognize on the transfer?

Rita forms Finch Corporation by transferring land (basis of $125,000; fair market value of $750,000) which is subject to a mortgage of $375,000. Two weeks prior to incorporating Finch, Rita borrows $125,000 for personal purposes and gives the lender a second mortgage on the land. Finch Corporation issues stock worth $250,000 to Rita and assumes the two mortgages on the land. What are the tax consequences to Rita and to Finch Corporation?

A city contributes $500,000 to a corporation as an inducement to locate in the city. Within the next 12 months, the corporation uses the money to purchase property. The corporation has income of $500,000 and must reduce its tax basis in the property by the same amount.

Kim, a real estate dealer, and others form Eagle Corporation under § 351.Kim contributes inventory (land held for resale) in return for Eagle stock.The holding period for the stock includes the holding period of the inventory.

In structuring the capitalization of a corporation, the tax law is neutral for the investor as to debt versus equity financing.

Stock in Merlin Corporation is held equally by Jane, Eve, and Fred.Merlin seeks additional capital to buy a valuable tract of land that will cost $6,000,000.Jane, Eve, and Fred propose to loan Merlin $2,000,000 each, taking from Merlin a $2,000,000 ten-year note with interest payable annually at five points above the prime rate.Merlin Corporation has current taxable income of $7,000,000.How are the payments on the notes treated for tax purposes?

Erica transfers land worth $500,000, basis of $100,000, to a newly formed corporation, Robin Corporation, for all of Robin's stock, worth $300,000, and a 10-year note.The note was executed by Robin and made payable to Erica in the amount of $200,000.As a result of the transfer:

Ruth transfers property worth $200,000 (basis of $60,000) to Goldfinch Corporation.In return, she receives 80% of its stock (worth $180,000) and a long-term note, executed by Goldfinch and made payable to Ruth (worth $20,000).Ruth will recognize no gain on the transfer.

Because services are not considered property under § 351, a taxpayer must report as income the fair market value of stock received for such services.

In a § 351 transaction, if a transferor receives consideration other than stock, the transaction can be taxable.

To help avoid the thin capitalization problem, it is advisable to make the repayment of the debt contingent upon the corporation's earnings.

One month after Sally incorporates her sole proprietorship, she gives 25% of the stock to her children.Section 351 cannot apply to Sally because she has not satisfied the 80% control requirement.