Question

Elena forms a new C Corporation named “Pal-Nova, Inc.” this year. She contributes property basis $100,000 and cash of $25,000 to the Corporation in exchange for 100% shares of the Corporation. The Corporation issues 100 shares to her and issues a promissory note of $25,000. Is this tax-free transaction under Section 351? What if Elena immediately after incorporation, transfers 50 shares to her son, Nicholai? Would the benefits of Section 351 still prevail?

Answer 1

Section 351 allows tax free incorporation transfer if certain conditions are met, along with definition in sec 368(c)of the corporation, the property transferred by an individual to a corporation in exchange for stock in the corporation, the transferor is in control immediately after the exchange.

Sec 368(c) defines control as the ownership of stock possessing at 80% of the total combined voting power of all classes of stock.

In this question, Elena is entitiled to a 100% voting power at the time of transfer but loses it to 50% as soon as the transfer of 50 shares to her son Nicholai.

Going by the definition of section 351, it is a tax free transfer.

According to section 368(c) benefits of section 351 will not prevail after the shares are transferred to her son, Nicholai.