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BK-CPA
BK-CPA, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 796
Experience:  Owner of a CPA firm
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I plan to tranfer the assets and liabilities of my business

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I plan to tranfer the assets and liabilities of my business to Newco in exchange for all of Newco's stock. The assets have a $250,000 basis and an $800,000 FMV. I also plan to tranfer $475,000 of business related liabilities to Newco. Under Sec. 375(c), can I avoid recognizing a $175,000 gain (the excess of liabilities over the basis of assets tranferred) by trasferring a $175,000 personal prommisory note along with the assets and liabilities? Can you let me know how or where did you get the facts in detail from? EX. what sec.
Submitted: 3 years ago.
Category: Tax
Expert:  BK-CPA replied 3 years ago.

Hello and thank you for your question.

 

I believe you mean IRC 357(c). There are exceptions.

 

357(c): "...if the sum of the amount of the liabilities assumed exceeds the total of the adjusted basis of the property transferred pursuant to such exchange, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of property which is not a capital asset, as the case may be. "

 

If you remain personally liable for the debt, and you continue to bear the economic risk associable with the debt (can be facts and circumstances based), then you may be able to argue that you have basis. If the corporation truly assumes your debt, and you no longer bear the economic risk of loss with respect to the debt, then you will not be able to claim that you have basis based on the debt. The internal revenue code and regulations can help us clarify when a shareholder is considered to have his debt assumed by the corporation (generally, I believe we'll find your debt is assumed by the corporation). We can go that route, but lets move on for now.

 

IRC 357(c)(2) and (3) state exceptions to IRC 357(c)(1)

 

Here they are (I'll clarify below):

 

http://www.law.cornell.edu/uscode/26/usc_sec_26_00000357----000-.html

 

(2) Exceptions Paragraph (1) shall not apply to any exchange-

(A) to which subsection (b)(1) of this section applies, or

(B) which is pursuant to a plan of reorganization within the meaning of section 368 (a)(1)(G) where no former shareholder of the transferor corporation receives any consideration for his stock.

 

(3) Certain liabilities excluded

(A) In general If a taxpayer transfers, in an exchange to which section 351 applies, a liability the payment of which either-

(i) would give rise to a deduction, or

(ii) would be described in section 736 (a), then, for purposes of paragraph (1), the

amount of such liability shall be excluded in determining the amount of liabilities

assumed.

(B) Exception Subparagraph (A) shall not apply to any liability to the extent that the incurrence of the liability resulted in the creation of, or an increase in, the basis of any property.

 

....

 

 

 

....

 

 

IRC 357(c)(2)(A) above refers to the tax avoidance implications of "messing with" the basis rules in the section, here, at 357(b)(1) and (2):

 

(b) Tax avoidance purpose

 

(1) In general If, taking into consideration the nature of the liability and the circumstances in the light of which the arrangement for the assumption was made, it appears that the principal purpose of the taxpayer with respect to the assumption described in subsection (a)-

 

(A) was a purpose to avoid Federal income tax on the exchange, or

 

(B) if not such purpose, was not a bona fide business purpose, then such assumption (in the total amount of the liability assumed pursuant to such exchange) shall, for purposes of section 351 or 361 (as the case may be), be considered as money received by the taxpayer on the exchange.

 

(2) Burden of proof In any suit or proceeding where the burden is on the taxpayer to prove such assumption is not to be treated as money received by the taxpayer, such burden shall not be considered as sustained unless the taxpayer sustains such burden by the clear preponderance of the evidence.

 

...

...

...

 

 

 

IRC 736(a) refers to payments to deceased or retiring partners. These liabilities do not have to be counted for the 357 purposes along with payments on liabilities that give rise to a tax deduction (IRC 357(c)(3) above). Also, if you have a reorganization in accordance with 368(a)(1)(G) implying a chapter 11 case, you may not have to include liabilities for 357 purposes.

 

Aside from the above exceptions, you generally cannot "magically" create a shareholder note to get out of the IRC 357 rules. I am sorry if this is not what you want to hear.

 

I am happy to clarify anything further for you with respect to your question. Please don't hesitate to reply if so! Thank you for your question!!



Edited by BK-CPA on 12/1/2010 at 3:36 AM EST
Customer: replied 3 years ago.
<p>Will you be able to give me a brief explaination of why not so i can have a better undestanding? I thought i will be able to understand the reason with the codes but i'm confuse. Do you have any recommendations? Thanks </p>
Expert:  BK-CPA replied 3 years ago.

I am happy to clarify further.

 

The above code highlights the consequences of creating a transaction out of tax avoidance. Namely, the full amount of the liabilities assumed will "be considered as money received by the taxpayer on the exchange." This is not what you want as I assume you would agree, therefore, due to the consequences associated with setting up a loan for the purposes of avoiding tax under IRC 357, I assume you would rather just choose to recognize tax, as applicable.

 

If you do not transfer the liabilities to the corporation, and maintain rather personal liability and only transfer the assets to the corporation with respect to legal title and economic risk (assets secured by debt may lead to the debt being treated as assumed by the corporation generally), then you may not have liabilities in excess of basis on the transfer. This would prevent tax on the exchange per IRC 357.

 

Again, I hope this is helpful. Please don't hesitate if I can again clarify further with respect to your question!! Thank you again!

Customer: replied 3 years ago.
so the issue will because is a personal promissory note?
Expert:  BK-CPA replied 3 years ago.

There are two issues:

 

The first issue is tax avoidance because liabilities are being transferred to a corporation, tax may be recognized under 357, a note to balance the equity and avoid tax that lacks business purpose likely isn't going to be wise given the consequences presented above, and these notes in general may not cut it with reference to the above burden of proof or "clear preponderance of the evidence" requirement.

 

The other issue (question) is, as an alternative, can you refrain from transferring the liabilities until a later date or not at all, and instead, transfer only the assets to the corporation? This would allow you to escape the tax implications of IRC 357 on the transfer because you would refrain from transferring liabilities in excess of basis.

 

I know this is tricky stuff!! No worries!!! Thanks again!!!!

 

BK-CPA, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 796
Experience: Owner of a CPA firm
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