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Barbara Lamar
Barbara Lamar, Tax Lawyer, CPA
Category: Tax
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Experience:  JD, MBA University of Texas at Austin, over 18 years representing small businesses
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SOLE PROPRIETORSHIPS AND CORPORTATIONS

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A SOLE PROPRIETORSHIP ON AN ACCURUAL BASIS (HE IS SUCCESSFUL,) HE INCORPORATES TO ACQUIRE ADDIIONAL CAPITAL AT MORE REASONABLE RATES. HE TRANSFERS BUSINESS ASSETS FMV 1 MILLION (ADJUSTED BASIS 200K) WITH THE ASSOCIATED DEBT 325k TO THE NEWLY FORMED CORPORATION. IS THIS TRANSACTION TAXABLE? IF SO WHAT WAYS CAN LIABILITY BE REDUCED? I THOUGHT THAT WHERE A SOLE PROPRIERTOR INCOPORATES HIS GOING BUSINESS, THE CORPORATION IS LIABLE FOR INCOMETAX ONLY UPON EARNINGS FROM THE DATE OF INCORPORATION (IS THIS ASSUMPTION CORRECT?) AND IF SO WHERE CAN I FIND IT IN THE IRS CODE,OR PRIMARY INFORMATION.
THANKS
A complete answer to your questions is beyond the scope of this question & answer forum. The best I can do is give you a general overview --

In general, transfers of assets to corporations by shareholders in exchange for stock are not taxable. However, there are several circumstances under which such transfers may be taxable, and you've mentioned a couple of them in your first sentence: where the transferred asset has appreciated in value since the shareholder acquired it and where the asset is subject to debt in excess of its basis. Without knowing the details, it's impossible to say how the shareholder could reduce the tax liability.

Section 351 of the Tax Code deals with transfers to corporations. You can find it online here:
http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=browse_usc&docid=Cite:+26USC351

In case this link doesn't work, do a search on U.S. CODE, TITLE 26, Subtitle A, CHAPTER 1, Subchapter C, PART III, Subpart A, Sec. 351.

(even though this is part of Subchapter C, it also applies to S Corporations)

Since this is a fairly complex area of tax law, the shareholder would be wise to buy a couple of hours of consultation time from a good tax lawyer or CPA.



Customer: replied 11 years ago.
Reply to Barbara Lamar's Post: My question, will a sole proprietor be taxed if he incorporates his business, if he is to incoporporate it would help him with capital, and restructuring. I looked at Rouss v. Bowers, (7AFTR 8473 (30F.2d 628) It states (where a sole proprietor incorporates his going business, the corporatiosn is liable for income tax only upon earnings from the date of incorporationm and anything prior to that the sole proprietor is responsible) I just wanted to know if this is correct. And if not could you direct me in the right directions.

Again,

Thanks
You are correct that the corporation will only be liable for taxes that accrue after its existence begins. However, for the person who contributes appreciated property, and/or property subject to debt inexcess of the contributor's basis, the transfer to the corporation can be a taxable event.
Customer: replied 11 years ago.
Reply to Barbara Lamar's Post: He still regains control of his corporation, so does that mean that under the General rule Title 26, Subtible A, Chapter 1,Subchapter C Part III, Subpart A section 351 that there is no gain or loss?((No gain or loss shall be recognized if property is transfrred to a Corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368 (c)) of the corportaon.)) Nothing has changed with his business other than its form of operation,a business justification exists for changing its form to that of a corporation, and he has enjoyed no personal gain from the transaction. Even though the proprietorship's liabilities transferred exceed the basis of the assets transferred, this transaction is tax free? Am I correct in this analysis? And since this sole proprietorship was on an accural basis is there any other considerations regarding the sole proprietorship?

Thanks!
The shareholder would probably be okay if he was transferring appreciated property with debt less than his basis. But if the corporation is going to pay off the debt, this looks to me as though the shareholder is getting "boot" in addition to stock to the extent the debt is greater than the shareholder's basis. So it looks as though the transaction is part contribution of assets in exchange for stock and part a sale that would result in taxable gain to the shareholder.

The shareholder can probably structure the deal to avoid any tax, but from what you've said, I don't think a trasfer of the asset to the corporation and assumption of the debt by the corporation would be entirely tax free. There are a number of variations: for example the shareholder could continue to own the assets and lease them to the corporation; or the shareholder could transfer the assets without tranferring the debt.

With respect to the shareholder's accounting method, if the corporation is going to use a different accounting method, it would be best not to transfer accounts receivable or accounts payable to the corporation. Otherwise, transfer of accounts receivable to the corporation should not cause a problem.
Barbara Lamar, Tax Lawyer, CPA
Category: Tax
Satisfied Customers: 188
Experience: JD, MBA University of Texas at Austin, over 18 years representing small businesses
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