Question

Barry, Dan and Edith form a new corporation. Barry and Dan each contribute property in exchange for stock. Within two weeks after the formation, the corporation issues additional stock to edith in exchange for property. Barry and Dan each hold 10,000 shares and Edith will receive 9,000 shares. Which transactions will qualify for business recognition?

a. only the first transaction will qualify for nonrecognition
b. only the second transaction will qualify for nonrecognition
c. because of the step transaction doctrine, neither transaction will qualify
d. both transactions will qualify under sec. 351 if they are part of the same plan of incorporation

Answer 1

d. both transactions will qualify under sec. 351 if they are part of the same plan of incorporation

Both the initial stock issuance by Barry and Dan, and the subsequent issuance to Edith could qualify for nonrecognition treatment under Section 351 if they are part of the same incorporation plan. Barry, Dan, and Edith will control the corporation after the exchanges, enabling them to potentially defer gains or losses from the property exchanged for stock.

Step-by-step explanation:

The question relates to whether the initial and subsequent stock issuances for property by Barry, Dan, and Edith in their new corporation will qualify for nonrecognition treatment under Section 351 of the Internal Revenue Code. Answer D is correct: Both transactions will qualify under Section 351 if they are part of the same plan of incorporation.

This section allows shareholders to defer recognizing a gain or loss when they transfer property to a corporation in exchange for its stock, provided that immediately after the exchange, they are in control of the corporation, which means holding at least 80% of the total combined voting power and value of the stock.

Since Barry, Dan, and Edith together would control 100% of the corporation after both transactions, provided that there was a prearranged plan that included both exchanges, they can qualify for nonrecognition of gain. However, this is conditional on the fact that both transactions were originally intended as part of the same overall plan for forming the corporation.