Lesson 8.3.2 Tax Consequences: Applications

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From the course by University of Illinois at Urbana-Champaign

Taxation of Business Entities I: Corporations

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University of Illinois at Urbana-Champaign

Taxation of Business Entities I: Corporations

22 ratings

Course 3 of 5 in the Specialization U.S. Federal Taxation

This course provides an introduction to the U.S. federal income taxation of corporations and their shareholders. The course focuses on the relevant provisions of Subchapter C of the Internal Revenue Code, as well as related Treasury Regulations and judicial opinions, governing corporate formation, operations, distributions, and liquidation. Practical in-class study problems facilitate self-discovery of technical tax knowledge along with the development of a variety of professional skills and attitudes.

From the lesson

Module 8: Corporate Reorganizations

In this module, you will explore corporate reorganizations. First, some background on the history of corporate restructuring will be given. Next, you will be introduced to the different types of tax-deferred reorganizations. Finally, you will learn analyze the tax consequences of these reorganizations.

Lesson 8.3.1 Tax Consequences: Concepts2:47

Lesson 8.3.2 Tax Consequences: Applications5:31

Meet the Instructors

Michael P Donohoe, PhD, CPA
Associate Professor of Accountancy and PwC Faculty Fellow
Department of Accountancy, Gies College of Business

Let's exam the tax consequences of qualified reorganisations using Sunchaser Shakery.

Nicholas transferred all of his stock in

Sunchaser Shakery Corporation to Marley Corporation in a Type A merger.

In exchange, he received stock and Marley worth $800,000 and $200,000 cash.

His basis in his stock was $250,000.

What amount of gain (if any) does Nicholas recognize,

and what is his basis in the Marley shares?

So when a Type A merger,

we're going to compute gain or loss,

just like we normally would in a property transaction beginning with the amount realized.

When he receives $800,000 of stock, $200,000 of cash.

So it's total amount realized is $1 million.

The adjusted basis of the property he gives up is

250,000 and so we

compute a realized gain of $750,000.

So in a Type A merger that qualifies,

then it should not be recognized.

However, we know that we have boot present.

So he will recognize a gain to the extent of the boot received,

which is the cash in this case.

So of the $750,000 realized gain,

he will recognize $200,000.

His basis in the shares that he

receives is computed using our formula that we've seen many times.

That is carry over exchange basis $250,000,

plus any gain recognize $200,000,

minus the fair market value of any boot received $200,000,

and we don't have any liabilities in this situation.

So his basis is $250,000.

Under a Type B reorganization plan adopted this year,

Nicholas exchange 100 shares of

Sunchaser Shakery Corporation common stock with a basis of

$355,000 for 400 shares of Marley Corporation worth $549,000.

What amount of gain or loss (if any) does Nicholas recognize,

and what is his basis in the Marley shares?

As this is a type B stock for stock acquisition,

there is no gain or loss recognize unless there is boot present.

But as we can see from the facts of the problem,

there is no boot present,

thus, there is no gain recognized.

In terms of his basis,

in a non-taxable transaction,

he will receive carry over or exchange basis.

In other words, $355,000.

Pursuant to a reorganization plan

adopted this year that meets all required general principles,

Sunchaser Shakery Corporation exchanged property with a basis of $50,000 for

50,000 shares of Marley Corporation (worth $520,000 at that time).

Sunchaser was liquidated shortly thereafter,

with its sole shareholder, Nicholas,

receiving the Marley shares.

Nicholas had a $130,000 basis in his Sunchaser shares.

What are the tax effects of the reorganization?

As this is an asset for stock exchange,

in other words, a Type C reorganization,

there is no gain or loss to

recognize unless there's any boot received.

And here, he received nothing but stock in Marley.

Thus, there is no gain or loss recognition.

As before and as in most cases where is a non-taxable transaction,

the basis that he will receive is the carry over or exchange basis.

In other words, $130,000.

Sunchaser Shakery Corporation, which is owned equally by four individuals,

owns all of the stock of Sea Breeze,

Inc. Sea Breeze was acquired six years ago and is now worth $100,000 a basis of $30,000.

Sunchaser distributes the Sea Breeze stock

equally to the four shareholders as part of a spin-off.

What amount and type of income do the shareholders a Sunchaser recognize if

E&P was $300,000 at the time of the distribution?

So assuming all spin-off requirements are met,

there is no gain or loss recognition as this is a Type D reorganization.

As part of a recapitalization of Sunchaser Shakery Corporation,

Nicholas exchanged 100 shares of his stock with a basis of

$58,000 for 100 shares of a new class of stock worth $208,000.

What amount of gain or loss (if any) does Nicholas recognize?

So recall, that recapitalizations are Type E reorganisations.

Thus, no gain or loss is recognize.

If stock for stock exchange occurs pursuant to a reorganization plan.

In this case, there is no exchange with another corporate entity,

thus, there is no gain or loss recognized.

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