Chapter 18 Corporations: Organization And Capital Structure

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Problems
26. LO.1, 3 Seth, Pete, Cara, and Jen form Kingfisher Corporation with the following consideration:
Consideration Transferred
Basis to
Transferor
Fair Market
Value
Number of
Shares Issued
From Seth—
Inventory $30,000 $96,000 30*
From Pete—
Equipment ($30,000 of depreciation taken by Pete in prior years) 45,000 99,000 30**
From Cara—
Proprietary process 15,000 90,000 30
From Jen—
Cash 30,000 30,000 10 * Seth receives $6,000 in cash in addition to the 30 shares. ** Pete receives $9,000 in cash in addition to the 30 shares.
Assume that the value of each share of Kingfisher stock is $3,000. As to these transactions, provide the following information:
a. Seth’s recognized gain or loss. Identify the nature of any such gain or loss.
b. Seth’s basis in the Kingfisher Corporation stock.
c. Kingfisher Corporation’s basis in the inventory.
d. Pete’s recognized gain or loss. Identify the nature of any such gain or loss.
e. Pete’s basis in the Kingfisher Corporation stock.
f. Kingfisher Corporation’s basis in the equipment.
g. Cara’s recognized gain or loss.
h. Cara’s basis in the Kingfisher Corporation stock.
i. Kingfisher Corporation’s basis in the proprietary process.
j. Jen’s recognized gain or loss.
k. Jen’s basis in the Kingfisher stock.
l. During discussions relating to the formation of Kingfisher, Seth mentions that he may be interested in either (1) just selling all of his inventory in the current year for its fair market value of $96,000 or (2) proceeding with his involvement in Kingfisher’s formation as shown above but followed by a sale of his stock five years later for $90,000. What would be the tax cost of these alternative plans, stated in present value terms? Referring to Appendix G, assume a discount rate of 6%. Further, assume Seth’s marginal income tax rate is 35% and his capital gains rate is 15%.
27. LO.1, 3 Tom and Gail form Owl Corporation with the following consideration:
Consideration Transferred
Basis to
Transferor
Fair Market
Value
Number of
Shares Issued
From Tom—
Cash $ 50,000 $ 50,000
Installment note 240,000 350,000 40
From Gail—
Inventory 60,000 50,000
Equipment 125,000 250,000
Patentable invention 15,000 300,000 60
The installment note has a face amount of $350,000 and was acquired last year from the sale of land held for investment purposes (adjusted basis of $240,000). As to these transactions, provide the following information:
a. Tom’s recognized gain or loss.
b. Tom’s basis in the Owl Corporation stock.
c. Owl Corporation’s basis in the installment note.
d. Gail’s recognized gain or loss.
e. Gail’s basis in the Owl Corporation stock.
f. Owl Corporation’s basis in the inventory, equipment, and the patentable invention.
g. How would your answers to the preceding questions change if Tom received common stock and Gail received preferred stock?
h. How would your answers change if Gail was a partnership?
28. LO.1, 7 Jane, Jon, and Clyde incorporate their respective businesses and form Starling
Corporation. On March 1 of the current year, Jane exchanges her property (basis of $50,000 and value of $150,000) for 150 shares in Starling Corporation.
On April 15, Jon exchanges his property (basis of $70,000 and value of $500,000) for 500 shares in Starling. On May 10, Clyde transfers his property (basis of $90,000 and value of $350,000) for 350 shares in Starling.
a. If the three exchanges are part of a prearranged plan, what gain will each of the parties recognize on the exchanges?
b. Assume that Jane and Jon exchanged their property for stock four years ago, while Clyde transfers his property for 350 shares in the current year. Clyde’s transfer is not part of a prearranged plan with Jane and Jon to incorporate their businesses. What gain will Clyde recognize on the transfer?
c. Returning to the original facts, if the property that Clyde contributes has a basis of $490,000 (instead of $90,000), how might the parties otherwise structure the transaction?
29. LO.1 Michael Kennedy (1635 Maple Street, Syracuse, NY 13201) exchanges property (basis of $200,000 and fair market value of $850,000) for 75% of the stock of Red Corporation. The other 25% is owned by Sarah Mitchell, who acquired her stock several years ago. You represent Michael, who asks whether he must report gain on the transfer. Prepare a letter to Michael and a memorandum for the tax files documenting your response.
30. LO.1 John organized Toucan Corporation 10 years ago. He contributed property worth $1 million (basis of $200,000) for 2,000 shares of stock in Toucan (representing
100% ownership). John later gave each of his children, Julie and Rachel,
500 shares of the stock. In the current year, John transfers property worth $350,000 (basis of $170,000) to Toucan for 1,000 more of its shares. What gain, if any, will
John recognize on the transfer?
31. LO.1, 3 Ann and Bob form Robin Corporation. Ann transfers property worth $420,000 (basis of $150,000) for 70 shares in Robin Corporation. Bob receives 30 shares for property worth $165,000 (basis of $30,000) and for legal services (worth $15,000) in organizing the corporation.
a. What gain or income, if any, will the parties recognize on the transfer?
b. What basis do Ann and Bob have in the Robin Corporation stock?
c. What is Robin Corporation’s basis in the property and services it received from
Ann and Bob?
32. LO.1, 7 Rhonda owns 50% of the stock of Peach Corporation. She and the other
50% shareholder, Rachel, have decided that additional contributions of capital are needed if Peach is to remain successful in its competitive industry. The two shareholders have agreed that Rhonda will contribute assets having a value of $200,000 (adjusted basis of $15,000) in exchange for additional shares of stock. After the transaction, Rhonda will hold 75% of Peach Corporation and Rachel’s interest will fall to 25%.
a. What gain is realized on the transaction? How much of the gain will be recognized?
b. Rhonda is not satisfied with the transaction as proposed. How will the consequences change if Rachel agrees to transfer $1,000 of cash in exchange for additional stock? In this case, Rhonda will own slightly less than 75% of Peach and
Rachel’s interest will be slightly more than 25%.
c. If Rhonda still is not satisfied with the result, what should be done to avoid any gain recognition?
33. LO.1, 2, 3 Cynthia, a sole proprietor, was engaged in a service business and reported her income on the cash basis. On February 2, 2016, she incorporates her business as Dove Corporation and transfers the assets of the business to the corporation in return for all of the stock in addition to the corporation’s assumption of her proprietorship’s liabilities. All of the receivables and the unpaid trade payables are transferred to the newly formed corporation. The balance sheet of the corporation immediately after its formation is as follows:
Assets
Basis to Dove Fair Market Value
Cash $ 80,000 $ 80,000
Accounts receivable –0– 240,000
Equipment (cost $180,000; depreciation previously claimed $60,000) 120,000 320,000
Building (straight-line depreciation) 160,000 400,000
Land 40,000 160,000
Total $400,000 $1,200,000
Liabilities and Stockholder’s Equity
Liabilities:
Accounts payable—trade $ 120,000
Notes payable—bank 360,000
Stockholder’s equity:
Common stock 720,000
Total $1,200,000
Discuss the tax consequences of the incorporation of the business to Cynthia and to
Dove Corporation.
34. LO.1, 2, 3 Allie forms Broadbill Corporation by transferring land (basis of $125,000, fair market value of $775,000), which is subject to a mortgage of $375,000. One month prior to incorporating Broadbill, Allie borrows $100,000 for personal reasons and gives the lender a second mortgage on the land. Broadbill
Corporation issues stock worth $300,000 to Allie and assumes the mortgages on the land.
a. What are the tax consequences to Allie and to Broadbill Corporation?
b. How would the tax consequences to Allie differ if she had not borrowed the $100,000?
35. LO.1, 3 Rafael transfers the following assets to Crane Corporation in exchange for all of its stock. (Assume that neither Rafael nor Crane plans to make any special tax elections at the time of incorporation.)
Assets Rafael’s Adjusted Basis Fair Market Value
Inventory $ 60,000 $100,000
Equipment 150,000 105,000
Shelving 80,000 65,000
a. What is Rafael’s recognized gain or loss?
b. What is Rafael’s basis in the stock?
c. What is Crane’s basis in the inventory, equipment, and shelving?
d. If Rafael has no intentions of selling his Crane stock for at least 15 years, what action would you recommend that Rafael and Crane Corporation consider?
How does this change the previous answers?