Question

Anne and Michael own and operate a successful mattress business. They have decided to take the business public. They contribute all the assets of the business to newly formed Spring Corporation each in exchange for 20% of the stock. The remaining 60% is issued to an underwriting company that will sell the stock to the public and charge 10% of the sales proceeds as a commission. Prepare a memorandum for your tax manager explaining whether or not this transaction meets the tax-free requirements.

Answer 1

Anne and Michael's exchange of assets for stock in Spring Corporation is unlikely to meet tax-free requirements, as they will not have controlling interest post-IPO. A company doesn't guarantee a rate of return upon issuing stock. The board of directors makes decisions in a company with many shareholders.

Step-by-step explanation:

The transaction described involving Anne and Michael taking their mattress business public through the formation of Spring Corporation and exchanging assets for stock, needs to be analyzed to determine if it qualifies for tax-free treatment.

In general, for a transaction to be considered tax-free under specific U.S. Internal Revenue Code sections, such as Section 351, the exchange must involve property for stock, and the contributors must control the corporation immediately after the exchange.

However, because the facts mentioned indicate that Anne and Michael together will own only 40% and the remaining 60% of the stock is issued to an underwriting company, they do not meet the control requirement for a tax-free exchange.

When a company conducts an Initial Public Offering (IPO), it does not promise a specific rate of return. Investors may receive returns through dividends or capital gains, but these are not guaranteed. Decisions in a company owned by a large number of shareholders are typically made by the board of directors, who are elected by the shareholders.