Organizational Tax and Planning - Research Paper Example

Organizational Tax Research and Planning - Transfers to a Corporation al affiliation methods of transfers likely trigger a taxable event and how to present this information to a client A transfer of cash and assets to a company exclusively in trade for stock in the company, the exchange is not taxable if the transferor has full control of the company. In addition, the type of stock exchanged should not be nonqualified preferred stock. This taxation rule applies to an individual and groups who wish to reassign assets to a company. The same rule applies regardless of an existing corporation or a new corporation is being formed (Hall, 2006). Tax exemption rule with regards to substitution of assets for stock does not hold in the following circumstances. The stock is obtained in exchange for the company’s debt (except for a security) or interest accruing from the company’s liability, which accrued while the transferor held the liability. The property is transferred due to bankruptcy, and/ or comparable transaction in substitution of stock utilized to pay the company creditors. The taxation rule also does not hold given that the company is an investment company. An individual or group who are party to property exchange for stock has to attach returns on their income and a complete statement of facts relevant to the exchange. Categories and ways of transfers likely to generate taxable events Control of the corporation For an individual or group to have entire control of the business after the exchange, they must own a minimum of 80% of all shares of every class of shares that is allowed to vote. The transferor must also own 80 percent of the existing shares of every category of company’s nonvoting stock. The number of shares determines the voting power, and this implies that the transferor or group of transferors must have the majority control. Having less than 80 percent control thus triggers taxation. Illustration Client, jean and john purchase property for $ 1million. They both arrange for a corporation with $20 million fair market value. Client and jean reassign the assets to the company for its entire authorized stock that has a book value of $20m. No transaction party; that is Client, jean, john or the corporation recognizes gain. Illustration 2 Client, jean and john transfer property worth $8M to a company in substitution for stock whose fair market value is $24M. This represents a 60% of every stock class in the corporation. Supposing the other 40% of the company’s stock was sold off to someone else, then the taxable gain that Client, jean and john recognize is $16M from the exchange as they do not have the majority control. Provision of services With regards to substitution of assets for stock, service is not considered as property. Therefore, the value of stock to be received as a result of rendering a service will be considered as income to the stock recipient. Therefore, rendering service in exchange for stock will trigger a taxable event as illustrated below. Client, jean and john transfer property worth $0.9M and offer services worth $0.1M to a company in exchange for stock worth $1M. Supposing that Client, jean and john have the majority ownership in that corporation, no gain on earnings will be included in the property exchange. Nevertheless, the Client, jean and john recognize 0.1M income from the services they provided to the company and this will be taxable income. Low value property Property transfer in exchange for stock will be deemed as diminutive amount given that value calculated in fair market value terms is10% or less of the fair market worth of the stock and shares a corporation owns or to be acquired for services rendered by (client, jean and john); the transferors (IRS, nd). For illustration, Client, jean and john will not be taxed if they transfer property with a relative market worth $ 25M in substitution for stock whose relative market worth is $30M as this already meets the 10% requirement. Stock obtained in discrepancy to assets reassigned A transfer of property by a group of people does not imply that every individual will obtain stock in a fraction of the value of the property each transferred. If Client, jean and john decide to apportion stock on the basis of each person’s property value, this will be taken as if the stock was received equally, with then a quantity of it utilized to compensate services, as well as to meet the transferors’ requirements (IRS, nd). Obtaining funds or other assets If a transferor gets property or money other than stock, the gain has to be recognized. For instance, if client, john and jean receive property and money on top of stock, the taxable gain equals to the sum of cash obtained and the fair market price of the other asset obtained. Nonqualified preferred stock Offering property in exchange for nonqualified stock is taken as property rather than stock. Nonqualified stock results in taxable gains as the possessor has the mandate to necessitate the issuer to purchase the stock. The rate of dividend on nonqualified stock varies with interest rates and other similar indices. As a result, it may result in gains, which are taxable. Liabilities If the company takes on the debts of Client, jean and john on property exchange for stock, exchange is not taken as if the three received property of cash. There are exclusions to liability treatment. If the debt that the company takes on exceeds the adjusted basis in the assets transferred, taxable gain is recognized only on the difference. Nonetheless, zero profit is acknowledged if the debt assumed results in a reduction when paid. If there is no justifiable reason for the company to assume the transferors’ debts; or if the reason for exchange is to evade income tax (IRS, nd). Illustration Client, jean and john transfer property in exchange for stock. The three attain control soon after the transfer. They also receive $ 1.3M in the transaction. Their adjusted basis in the reassigned asset is $ 2.1M. The stock they obtain supposedly has a fair market price of $1.5M. The company also assumes $ 0.6M credit on the asset in which the three are liable. The taxable gain resulting from the transaction is calculated using the following method. Fair marketplace price of the stock obtained $1.5M Money received $1.3M Credit assumed by the company $0.6M Total obtained $ 3.4 Less adjusted basis of transferred property $ 2.1M Realized gain $1.3M Recognized gain $1.0M 2. Kinds of reassigns likely to add to the possibility of an audit by IRS, as well as the influence on the given advice Non cash charitable donations Transferring donations for charity, which are not in the form of cash increases chances of an IRS audit. The reason is that the donations may be overestimated in a bid to reduce taxable gain on the part of the corporation. Transfers from or to a subsidiary corporation If the client owns another company, which may be treated as a subsidiary to the present ones, any transfer of property or cash from the corporation might attract IRS audit. The reason is that transfers may be viewed as means of increasing expenses, and thus a means of reducing taxable amount. Home office donations Some businesses transfer some of their funds on the basis that they have home offices. Majority of people do a little work at homes and claim tax benefits that are not deserved. Therefore, Client and his partners should be careful with home office transfers as IRS can make them prove “exclusive use” of home office for business purpose. In the case client home deductions are found to be a mere business use, the corporation may be fined as this might be viewed as a means of evading tax liability. Business entertainment Transfer of funds for purposes of company related trips and entertainment are viewed as a source of expense overstatement. Overstating business expenses results in the reduction of profits available for taxation. As such, business entertainment and transfer of such may increase risks of IRS audit (Reeves, 2013). 3. The most beneficial kinds and ways of assets and service reassigns to reduce every tax burden and audit risk The most significant methods of transfer that result in minimal tax liability and less IRS audit are the majority ownership method and transfer of high value property. Control of a corporation after the exchange arises if the value of the property exchanged becomes more than 80 percent of all classes of shares that a corporation owns. Having more than eighty percent ownership leaves the entire control in hands of the transferor, and the exchange is always non-taxable. Transfer of property whose value is relatively high, exceeding the 10% rule does not give rise to taxation. It is essential for the client to avoid rendering services as a means of substitution of assets for stock. Rendering service especially to a subsidiary in exchange for a stock may attract IRS audit on related party transaction (UN.ORG, nd). For illustration, suppose Client, jean and john render services in substitution for stock in company XY Company. The transaction may increase the risk of audit as transaction parties are related. As such, they compromise on some issues in a bid to minimize tax liability. References Hall, C.W. (2006). Tax considerations of transfers to and distributions from the C or S Corporation. Retrieved on 8 July 2013 from IRS. (nd). Property exchanged for stock. Retrieved on 8 July 2013 from < http://www.irs.gov/publications/p542/ar02.html#en_US_2011_publink1000257749>. Reeves, J. (2013). Five tax mistakes most likely to spur an IRS audit. Retrieved on 8 July 2013 from . UN.ORG (nd). Transfer pricing methods. Retrieved on 8 July 2013 from < http://www.un.org/esa/ffd/tax/2011_TP/TP_Chapter5_Methods.pdf> Read More