Transfers to Controlled Corporations: Related Problems (Portfolio 759)

Transfers to Controlled Corporations: Related Problems, written by Howard J. Rothman, Esq., Pamela M. Capps, Esq., Barry Herzog, Esq., and Mary Jo Brady, Esq., all of Kramer, Levin, Naftalis & Frankel, discusses the relationship between §351 and other provisions of the Code.  

In general, §351 provides that no gain or loss is recognized by transferors of property to a corporation solely in exchange for the stock of the transferee if, immediately after the exchange, the transferors are in control of the transferee. When a transaction satisfies the requirements of §351, other sections of the Code and certain nonstatutory rules will govern other aspects of the incorporation. For example, a corporation that incorporates under §351 is treated as a new taxpayer that is entitled to make certain elections (e.g., the adoption of a taxable year). 

In certain instances, the parties involved in a §351 exchange may want the transfer to be treated as a taxable exchange because of the favorable tax consequences that may result from that treatment. For example, if a transferor's basis in property that is transferred to a controlled corporation exceeds its fair market value, the transferor may want to consider having the transaction fall outside of §351 so that the loss can be recognized. 

This Portfolio analyzes the relationship between §351 and other provisions of the Code.  It compares the various methods of transferring property to a controlled corporation and describes the effect of, and problems arising from, the incorporation of a sole proprietorship, partnership, or limited liability company. 

The Portfolio also discusses the problems related to a §351 transaction involving foreign transferees or transferors, investment companies, and bank holding companies.  The authors analyze the relationship between §351 and the reorganization provisions of the Code, and they review the recordkeeping, filing, and ruling request requirements of a §351 transaction. 

Transfers to Controlled Corporations: Related Problems allows you to benefit from:

• Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
• Invaluable practice documents including tables, charts and lists
• Plain-English guidance from world-class experts
• Real-world and in-depth analysis that lets you explore various options
• Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and more
• Alternative approaches to both common and unique tax scenarios 

This Portfolio is part of the U.S. Income Portfolios Library, a comprehensive series that includes more than 200 Portfolios, which cover every federal tax topic with expert, in-depth analysis, and offer commentary on a wide range of federal taxation topics, including Compensation Planning, Deductions and Credits, Partnerships and Corporations, Special Pass-Through Entities, Corporate Reorganizations, Real Estate, Procedure and Administration, and more. 

Detailed Analysis

I. Comparison of Methods of Transferring Property to Controlled Corporations

A. General

B. Description of Certain Methods for Transferring Property to a Controlled Corporation

C. Recognition of Gain or Loss

1. Section 351(a) Tax-Free Exchange

2. Section 351(b) Boot Transaction

3. Combined Sale and § 351 Exchange

4. Exchange That Does Not Qualify Under § 351

5. Merger

6. Lease

II. Intentional Avoidance of Nonrecognition Treatment Under § 351

A. General

1. Increasing Basis of Transferred Property

2. Deferred Recognition of Income

3. Assurance of Character of Income

4. Recognition of a Loss

5. Recognition of Income

B. Techniques for Avoiding Nonrecognition Treatment Under § 351

1. Sale of Property to a Controlled Corporation

a. General

b. Determination of Debt/Equity Classification

c. Cases Holding a Purported Sale to Constitute a § 351 Exchange

d. Cases Holding a Transfer to Be a Sale

e. Analysis of the Cases

f. Double Taxation Resulting From Failure to Maintain Characterization as a Sale

2. Receipt of Boot

3. Failure to Satisfy Control Requirements

4. Alternative to Intentional Avoidance of Nonrecognition Treatment Under § 351

C. Planning Opportunities

III. Incorporation of an Active Business

A. General

B. Elections Available Upon Incorporation

1. Adoption of a Taxable Year

2. Selection of a Method of Accounting

a. Accrual Method of Accounting

b. Cash Receipts and Disbursements Method of Accounting

c. Inventory

d. Accounts Receivable

e. Accounts Payable

3. Electing S Corporation Status

4. Election and Deemed Election to Deduct Organizational and Start-Up Expenses

a. Organizational Expenses

b. Start-Up Expenses

c. Coordination of § 195 with Capitalization Rules

5. Depreciation Method

6. Recapture of Transferor's Depreciation

C. Carryover of Tax Attributes

1. Net Operating Loss and Net Capital Loss Carryforwards and Carrybacks

a. Net Operating Losses and Net Capital Losses of Transferor - § 351

b. Extinguishment of Net Operating Loss Carryforwards of Transferee Corporation - § 382(a)

2. Earnings and Profits - § 312

3. Basis and Holding Periods - § § 358, 362, and 1223

D. Special Miscellaneous Problems

1. Transfer of Income Rights

a. Nonrecognition of Income at the Time of a Transfer

b. Assignment of Income Doctrine

(1) General

(2) Cases Applying the Assignment of Income Doctrine

(3) Cases Not Applying the Assignment of Income Doctrine

(4) Summary of Cases

c. Clear Reflection of Income Doctrine - § § 446(b) and 482

(1) Change of Method of Accounting

(2) Allocation of Income

2. Tax Benefit Rule

3. Payment of Assumed Liabilities

4. Business Purpose, Continuity of Interest, Continuity of Business Enterprise Doctrines

5. Step Transaction Doctrine

E. Application of Other Statutory Provisions

1. Recapture of Investment Tax Credit - § 50 and Former § 47

2. Recovery of Tax Benefit Amounts - § 111

3. Contributions to the Capital of a Corporation - § 118

4. Gain on Sale of a Principal Residence - § 121 and Former § 1034

a. Exclusion of Gain on a Sale of a Principal Residence - § 121

b. Rollover of Gain on a Sale of a Principal Residence - Former § 1034

5. Depreciation - § 168

6. Amortization of Intangibles - § 197

7. Disallowance of Losses - § 267

8. Acquisitions Made to Evade or Avoid Income Tax - § 269

9. Redemptions Through Use of Related Corporations - § 304

10. Dispositions of Certain Stock - § 306

11. Liquidations - § 336

12. Limitations on Net Operating Loss Carryforwards and Built-in Losses - § 382

13. Disposition of Installment Obligations - § 453B

a. Installment Obligations of Third Parties

b. Installment Obligations of Transferee Corporations

14. Prepaid Subscription Income - § 455

15. Long-Term Contracts - § 460

16. Passive Activity Losses and Credits - § 469

17. Interest on Certain Deferred Payments - § 483

18. Like-kind Exchanges - § 1031

19. Exchanges of Stock for Property - § 1032

20. Involuntary Conversions - § 1033

21. Gain Exclusion for Small Business Stock - § 1202

22. Characterization of Gain from Transfer of Depreciable Property - § 1239

23. Section 1244 Stock - § 1244

24. Recapture of Depreciation - § § 1245 and 1250

a. Section 1245

b. Transferee's Disposition of Property Subject to Depreciation

c. Section 1250

25. Gain From Disposition of Farm Land - § 1252

26. Treatment of Amounts Received on Retirement or Sale or Exchange of Debt Instruments - § § 1272-1274

27. Market Discount Rules - § § 1276-1278

28. Tax Avoidance Transfers to Foreign Corporations - § § 367, 721, 684, and Former § 1491

29. Below Market Interest Rate Loans - § 7872

30. State Tax Considerations

F. Incorporation of a Partnership or Limited Liability Company Taxable as a Partnership

1. In General

2. The IRS's Position

a. Qualification Under § 351

b. Effect of the Corporation's Assumption of the Partnership's Liabilities

c. Basis of Corporation in the Assets Transferred

d. Basis of the Partnership/Partner's Interest in the Stock Received from the Corporation

e. Corporation's Holding Period in the Assets Received in the Exchange

f. Partnership/Partners’ Holding Period in the Stock Received in the Exchange

3. Other Issues Regarding Which Method of Incorporation to Choose

a. Implications of Chosen Method

(1) Collapsible Corporations (Repealed)

(2) Personal Holding Company

(3) Section 1244 Stock and § 1202 Stock

(a) Section 1244

(b) Section 1202

(4) S Corporations

(5) Section 754 Election and Mandatory Basis Adjustments

b. Investment Tax Credit Recapture

c. Depreciation Recapture

d. Section 737 Recognition of Precontribution Gain

e. Section 1239 Recognition of Ordinary Income

f. Other Considerations

(1) Timing of the Incorporation

(2) LIFO Inventory Recognition of Income

(3) Section 481 Accounting Adjustment

(4) Constructive Distributions

(5) State and Local Taxes

(6) Rule 144 Tacking

(7) Step Transaction Doctrine and Incorporation of Partnerships

4. Issues Relating to the Incorporation of a Preferred Partnership Interest

5. Issues Relating to the Incorporation of a Profits Interest

a. Receipt of a Profits Interest

b. Stock Received on Incorporation

c. Additional Issues

IV. Section 351 and the Reorganization Provisions

A. Relationship Between § 351 and the Reorganization Provisions

1. General

2. Significance of Distinguishing Between § 351 and Reorganization Transactions

3. Overlapping Operation of § 351 and the Reorganization Provisions

a. In General

b. Recognition of the Dual Applicability of the Two Provisions

(1) “B” Reorganizations

(2) “C” Reorganizations

(3) “D” Reorganizations

(4) “F” Reorganizations

(5) “A” Reorganizations

(6) “G” Reorganizations

(7) “E” Reorganizations

B. Application of § 351 to Nonstatutory Reorganization Criteria

1. The Business Purpose Doctrine

a. The IRS's Position

b. Judicial Decisions

(1) Cases Applying Business Purpose Doctrine

(2) Cases Not Applying the Business Purpose Doctrine

2. Continuity of Interest Doctrine

3. Continuity of Business Enterprise Doctrine

C. Acquisitive § 351 Transactions

1. National Starch Transaction

2. Continuing Interest

3. Horizontal Double Dummy Technique

a. Transfer of Property

b. The Control Group

c. Control

d. Control Immediately After the Exchange

D. Holding Company Structures

1. In General

2. Reasons for Using a Holding Company

a. Separation of Assets

b. Control of Shareholders

c. Avoidance of Regulatory Restrictions

d. International Tax Planning

e. State Tax Planning

3. Formation of Holding Company

4. Formation of a Holding Company by Automatic Conversion

E. Acquisition of a Partnership

F. Inversion Transactions

V. Transfers to Investment Companies - § 351(e)

A. General

B. Regulations and Rulings

1. The Diversification Requirement

a. Nonidentical Assets

b. Transfers of Diversified Portfolios

c. De Minimis Exception

d. Cash as a Diversifying Asset

2. The Transfer to an Investment Company Requirement

3. The Holding for Investment Requirement

VI. Transfers by U.S. Persons to Foreign Corporations

A. General

B. Transfers Beginning and Sales, Exchanges and Distributions Taking Place Before October 10, 1975

C. Transfers Beginning and Sales, Exchanges and Distributions Taking Place After October 9, 1975, and Before January 1, 1985

1. General

2. Transfers from the United States (Outbound Transfers)

3. Contributions to the Capital of a Controlled Foreign Corporation

4. Toll Charges

D. Transfers Occurring, and Sales, Exchanges, and Distributions Taking Place After December 31, 1984

1. General

2. Four Types of Toll Charges

a. Deemed Sale Toll Charge

(1) General Rule

(2) Active Trade or Business Exception

(3) Transfers of Stock or Securities

b. Tax Benefit Recapture Toll Charge

c. Deemed Royalty Toll Charge

d. Transfers of Stock of Foreign Corporations - § 367(b)

(1) Inclusion of § 1248 Amount

(2) Notice Requirements

(a) Persons Subject to § 367(b) Notice Requirements

(b) Time and Manner of Filing the Notice

(c) Information Required

3. Notification Requirement

VII. Transfers by Foreign Persons

A. Foreign Transfers by Foreign Corporations: § 367(b)

1. In General

2. Prior Law

B. Transfers of U.S. Real Property Interests

1. General

2. Application to § 351 Exchanges

3. Withholding

C. Branch Profits Tax

VIII. Filing and Recordkeeping Requirements; Ruling Requests

A. Filing Requirements

1. General

2. Filing Requirements of the Transferor

3. Filing Requirements of the Transferee Corporation

a. Section 351 Regulations

b. Section 6043(c) Regulations

B. Recordkeeping Requirements

C. Advance Ruling Requests

1. Issuance of Advance Rulings

a. Factual Information Required

b. Filing Procedure and Fees

2. Circumstances Under Which Advance Rulings Will Not Be Issued

Working Papers

Table of Worksheets

Worksheet 1 Incorporating a Partnership Under § 351: Summary of Tax Effects

Worksheet 2 General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984 (H.R. 4170, 98th Congress; P. L. 98-369), prepared by the Staff of the Joint Committee on Taxation, 420–437 (1984)

Worksheet 3 Conference Report on Taxpayer Relief Act of 1997 (P.L. 105-34) H. R. Conf. Rep. No. 220, 105th Cong., 1st Sess. (1997) (Excerpt - Limitation on Exception for Investment Companies Under § 351)

Worksheet 4 General Explanation of Tax Legislation Enacted in 1997 (H.R. 2014, 105th Cong.; P.L. 105-34) prepared by the Staff of the Joint Committee on Taxation, 182-185 (1997) (Excerpt - Limitation on Exception for Investment Companies Under § 351)

Worksheet 5 Conference Report on Taxpayer Relief Act of 1997 (P.L. 105-34) H. R. Conf. Rep. No. 220, 105th Cong., 1st Sess. (1997) (Excerpt on Repeal of § § 1491 – 1494)

Bibliography

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Treasury Regulations:

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Treasury Rulings:

Cases:

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