Tax-Free Contributions in Exchange for Corporate Stock
When a corporation is formed, its shareholders transfer money and property to the corporate entity in return for stock. Generally, if you transfer money or property into a corporation solely in exchange for stock of that corporation and you control the corporation immediately after the transaction, neither you nor the corporation recognizes any gain or loss resulting from the exchange. This general rule is not elective. If the statutory requirements of a tax-free exchange are met, neither gain nor loss will be recognized. The rule applies if you are an individual or if you are a member of a group that transfers property into a corporation. In addition, the exchange is tax-free no matter whether the corporation is being formed or whether it is already operating.
To be considered in control of a corporation, you or your group must own at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the outstanding shares of each class of nonvoting stock. To qualify as a tax-free exchange, this control must take effect immediately after the exchange. The "immediately after" requirement does not necessitate a simultaneous exchange. It is satisfied by a prearranged exchange that occurs in an orderly and expeditious manner.
An exchange of property for stock is not tax-free in the following situations: the corporation is an investment company; you transfer the property in a bankruptcy or similar proceeding in exchange for stock used to pay creditors, or; the stock is received in exchange for corporate debt or an interest in corporate debt that accrued while you held the debt.
If you perform services for the corporation and receive stock in exchange, the transaction is not entitled to tax-free treatment because services are not considered property. The value of the stock you receive is taxable to you as income.
The tax-free nature of an exchange of property for stock is not destroyed if you receive other property or cash along with stock despite the fact that the Internal Revenue Code states that the property must be exchanged solely for stock. You are required to recognize a gain (but not a loss) on any other property or cash ("boot") received only up to the amount of cash received or the fair market value of other property received. An assumption of your liabilities by the corporation is generally not treated as if you had received cash or other property.
Copyright 2011 LexisNexis, a division of Reed Elsevier Inc.
