Question

Betty joined Jim in forming DBJ Corp. Betty contributed appreciated land for 90 percent of the stock in DBJ. Jim received 10 percent of the DBJ stock valued at $15,000. Determine Jim's tax consequences in each of the following alternative scenarios.

Jim received the stock in exchange for providing computer-related services for the corporation. What amount of income or gain does Jim recognize on the exchange?

Answer 1

Jim has to recognize $15,000 as ordinary income for the stock received as compensation for computer-related services provided to DBJ Corp.

Step-by-step explanation:

Jim's tax consequences for receiving stock in exchange for services are based on the fair market value of the stock received. In essence, when Jim provides computer-related services to DBJ Corp and receives stock in return, the stock is treated as income for services rendered. The amount of income recognized by Jim is equal to the fair market value of the stock received, which in this case is stated as $15,000. Therefore, Jim has to report $15,000 as ordinary income on his tax return for the year in which the exchange occurred.

Consider the analogy of Babble, Inc., where the company's profits are distributed as dividends. If an investor purchases stock, they might receive dividends as income or could earn a capital gain upon selling the stock at a higher price. In Jim's scenario, there is no capital gain involved yet since he has not sold the stock; the stock is compensation for services and thus treated as ordinary income, not unlike a cash salary.