Mary and Sarah agree to go into business together selling college-licensed cloth
ID: 2562626 • Letter: M
Question
Mary and Sarah agree to go into business together selling college-licensed clothing. According to the agreement, Mary will contribute inventory valued at $210,000 in return for 80 percent of the stock in the corporation. Mary's tax basis in the inventory is $108,000. Sarah will receive 20 percent of the stock in return for providing accounting services to the corporation (these qualified as organizational expenditures). The accounting services are valued at $45,000. What amount of gain or loss does Mary realize on the formation of the corporation? What amount, if any, does she recognize? What is Mary's tax basis in the stock she receives in return for her contribution of property to the corporation? a. b. c. What amount of income, gain, or loss does Sarah realize on the formation of the corporation? What amount, if any, does she recognize? What is Sarah's tax basis in the stock she receives in return for her contribution of services to the corporation? d. ASSUME that Sarah received 25 percent of the stock in the corporation in return for her services e. What amount of gain or loss does Mary recognize on the formation of the f. What is Mary's tax basis in the stock she receives in return for her g. What amount of income, gain, or loss does Sarah recognize on the formation h. What is Sarah's tax basis in the stock she receives in return for her i. What tax advice could you give Mary and Sarah to change the tax corporation? contribution of property to the corporation? of the corporation? contribution of services to the corporation? consequences?Explanation / Answer
a) Mary realize a gain of $102,000 on this transfer, computed as follows :-
Mary is entitled to tax deferral under §351 (she transfers property to the corporation and controls the corporation immediately after the exchange.)
b) $108,000, a substituted basis equal to the basis of inventory transferred.
c) Sarah has compensation income of $45,000. Sarah is not entitled to tax deferral under §351 because services are not considered property.
d) Sarah's tax basis in the stock she receives is $45,000, equal to the income recognised on the receipt of the stock in exchange for services.
e) Mary is no longer entitled to tax deferral under §351 because she does not control the corporation immediately after her transfer of property (she must own 80 percent or more). As a result, she recognises gain of $102,000 on her transfer of property.
Fair Market Value of stock received $ 210,000 Less :- Adjusted tax basis of inventory transferred $ 108,000 Gain realized $ 102,000