Tax-Free Contribution to Corporation in Exchange for Stock

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Most Common Business Law Issues:

Do I Need to Recognize Any Income If I Contribute Money in Exchange for Stock When I Form a Corporation?

Generally no. There is no gain or loss recognized by the taxpayer (or a group of taxpayers) when:

1. Property is transferred by the taxpayer (or a group of taxpayers) to a corporation solely in exchange for stock in such corporation; and
2. Immediately after the exchange the taxpayer (or a group of taxpayers) is in "control" of such corporation.

However, this rule does not apply if the corporation is an investment company (e.g. corporation that holds and sells stocks as investments).

To Whom Does This Tax-Free Contribution Rule Apply?

1. Individuals
2. Trusts
3. Estates
4. Partnerships
5. Other Corporations.

If I Only Provide Personal Services In Exchange for Stock, Would That Qualify for Tax-Free Contribution Treatment?

No. Property, not services, must be transferred to the corporation in order for the tax-free treatment to apply. There are generally three things that are not considered property for the purposes of this tax-free contribution rule:

1. Services
2. Unsecured loan of the corporation
3. Accrued and unpaid interest on a loan of the corporation

If corporate stock is issued in exchange for the contribution of the above items, then the exchange will not qualify for tax-free treatment.

What Is "Control" for the Purposes of This Tax-Free Contribution Rule?

Generally, "control" means that after the transfer of property, the taxpayer (or a group of taxpayers) has:

1. At least 80% of the total combined voting power of all classes of stock entitled to vote; and
2. At least 80% of the total number of all other classes of stock.

"Control" does not require the taxpayer to have actual "control" over the affairs of the corporation (i.e. daily operations). "Control" in this case only refers to the ownership of the corporation.

Will My Transaction Be Disqualified from Tax-Free Contribution Treatment If I Receive Property Other Than Stock from the Corporation?

Not entirely. When a taxpayer receives property other than stock in this type of an exchange, he/she may still enjoy partial tax-free treatment on the transfer. In this case, gain from the exchange (i.e if the fair market value of the stock received exceeds the basis of the property transferred) needs to be recognized to the extent of:

1. The amount of cash received, plus
2. The fair market value of such other property received.

No loss is recognized by the taxpayer in this type of a transfer, even if property other than stock is received from the corporation.

Do I Need an Attorney to Help Me with My Tax Problems?

Tax laws are complex and ever-changing. Although there are various tax preparation softwares on the market that may help you with your tax problems, they cannot provide the same level of service that an experienced and knowledgeable tax attorney can. If you are unsure how to organize your corporation in a tax-free manner or you need someone to represent you before the IRS, a tax attorney can help you.

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Last Modified: 02-10-2015 10:28 AM PST

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