Question

Sam and Devon agree to go into business together selling college-licensed clothing. According to the agreement, Sam will contribute inventory valued at $182,000 in return for 80 percent of the stock in the corporation. Sam’s tax basis in the inventory is $124,000. Devon will receive 20 percent of the stock in return for providing accounting services to the corporation (these qualify as organizational expenditures). The accounting services are valued at $45,500.

1.What amount of income, gain, or loss does Devon realize on the formation of the corporation? What amount, if any, does he recognize?

2.What is Devon’s tax basis in the stock he receives in return for his contribution of services to the corporation

3.Assume Devon received 25 percent of the stock in the corporation in return for his services. What amount of gain or loss does Sam recognize on the formation of the corporation

4.What is Sam’s tax basis in the stock he receives in return for his contribution of property to the corporation

Answer 1

1) Devon has compensation income of $45500. Devon is not entitled to tax deferral under U.S. Code § 351 because services are not considered property.

2) $45500 Devon's tax basis in the stock he receives is $ 45500, equal to the income recognized on the receipt of the stock in exchange for services.

3) Sam is no longer entitled to tax deferral under §351 because he does not control the corporation immediately after his transfer of property (he must own 80 percent or more). As a result, he recognizes gain of $ 58000 (182000-124000) on his transfer of property

4) Sam’s tax basis in the stock he receives in return for his contribution of property is $ 124000, substituted basis equal to the basis of the inventory transferred