Research Paper on Section 351

Paper Type:  Research paper
Pages:  7
Wordcount:  1696 Words
Date:  2022-05-12


Typical transfer of property into a corporation to acquire stock is usually a taxable occurrence. This transaction is categorized as a sale where the corporation buys the property from you, and in return, it gets money. The difference between the tax basis and the stock value gains, based on the property transfer to the cooperation is yielded in a loss or gain. The Congress, therefore, enacted section 351 to eliminate tax liability when incorporating firms currently unincorporated. The Congress viewed a need to eliminate barriers to incorporation. The section gets rid of this barrier that unincorporated business face during incorporation. Congress wanted to allow unincorporated businesses to grow, unlimited by any immediate tax liabilities following the sale of property for stock. The provisions under Section 351 demonstrates Congress intention of postponing tax in intra-business rearrangements until the transferor extinguishes control and continuing interest in the property.

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Continuing Control after the Transfer

The Congress provided for forfeiture of taxation in the transfer of property until its disposal in substance value to outsiders. The application of Section 351 does not matter whether you are beginning a corporation with other people such as partners after forming a partnership, or by yourself. It does not also matter if you are investing an existing corporation. In all these cases, while exchanging property for stock in a corporation, section 351 (a) stipulates that any resulting tax can be deferred. Section 351 (a) outlined that no loss or gain should be recognized the party exchanges property for stock only and provided the party has control of the corporation after the exchange (Raabe, Young, Nellen, & Maloney, 2017). In this light, the control means that you own some stock amounting to at least eighty percent of the entire voting power exercisable on all stock classes that have voting rights. According Smith (2009) extends to the demonstration of similar ownership of outstanding shares in other stock categories,

The tax court views control requirement stipulated under Section 351 extinguishes when the transferor surrenders continuing interest in a sale transaction. In this case, the third party of the corporation does not engage in an exchange of property for stock. This is after a binding agreement between the corporation and the transferor (Schenk, 2017). However, the control requirements in section 351 may be held binding by the court of law in cases involving the transfer of stock received of a binding agreement after the property exchange. According to Cartano (2008) Rev. Rul. 84-111 shows were abiding provision under Section 351 where the transfer of property by the partnership, though losing control to the corporation within the guideline provided by section 368 (c) following previous plan to transfer the stock.

Section 351 permits tax-free incorporation transfers provided upon satisfaction of certain requirements. Firstly, the section requires the transfer of the property to one or more individuals limit to stock ownership in the corporation. Secondly, it requires proof that the transferor assumes control over the property instantly after the exchange. The requirement of 'immediately after exchange' is also quite uncertain and unclear leaving many unanswered questions; especially on how long 'immediately after exchange' should be. It is challenging to rule out the amount of time the control should persist after the sale for the exchange to satisfy the 'immediately after exchange' requirement. It is not also clear whether the transferor can assume ownership of eighty percent of the stock and relinquish such after a period (Martin D. Ginsburg, 2012). However, the navigation of this requirement necessitates care to avoid the controversy trap regarding ownership, control and continuing interest in the property.

Contingent Stock Rights and Escrowed Stock

Additionally, the fundamental requirement that transferors should demonstrate exercising control over the property immediately after the transaction has vague application. Such arises during instances when a group of individuals transferring property may collectively have control after the exchange despite the fact that no single person assumes control. Although such has attracted relatively few disputes, the immediately after requirement lacks concise meaning when considering whether the group of transferors exercise control (Dickinson, 2009). It becomes difficult to admit whether step transaction doctrine and mergers apply to the case. The vagueness creates an opportunity capable of spoiling the tax-free nature.

Failure to concise inclusion in the transaction yields uncertainty to determine if section 351 transaction captures stock or securities. The section requires the transferor to assume control over stock and not merely securities. However, it remains uncertain where the transferor receives securities accompanies by share transfer. Its typical interpretation implies that receipt of securities only in the exchange spoils the tax-free nature. Current position by IRS upholds the transferor receipt of stock fails where one lacked existing ownership in the corporation stock. Such instances break the tax-free status hence making the receipt of securities in exchange for property taxable (Peroni, Gustafson, & Pugh, 2008). The ascertainment of what constitutes securities and stocks becomes nettlesome. Limiting the transfer of property to stock or securities exchange implies receipt of money being a taxable gain recognition. The exact meaning of securities and stock lack in the code despite their relevance in the reorganization sections. Oddly, the inclusion of reorganization sections as relevant elements within the interpretation of section 351.

The regulations lack provisions for stock rights and stock warrants making it a contentious issue when distributed in exchange for property. Their exclusion becomes contentious particularly with other contexts of Sections 354 and 368 consider warrants to purchase stock are not stock. Upholding such a stance seems questionable especially in the treatment of contingent stock. It creates an odd experience where contingent stock rights feature issuance of warrants convertible to stock when contingencies occur. The issuance of contingent stock rights is unavoidable when the parties lack immediate clarity on the number of shares a transferor may get. Although issuance of contingent share rights arises from difficulty to ascertain, IRS position views them as neither securities nor stock (Smith, Raabe, & Maloney, 2009). The position contradicts several cases that consider contingent share rights equivalent to stock that Section 351 infers in its application.

The issuance of revenue procedure sanctifying similar treatment as securities and stock to fulfill Section 351 purpose. It requires demonstration of valid business purpose in the issuance of contingent rights, acquisition of additional stock, half of the maximum shares issuance. The requirement that stock issuances tied to the contingent stock rights should not arise from events and factors controlled by existing shareholders creates impossible compliance point. Typically, issuance of contingent stock arises from events caused by shareholders decisions. Again, necessitating prior ascertainment of shares issued when the contingencies occur defeats the principle of uncertainty rationalizing the contingency stock rights (Raabe, Young, Nellen, & Maloney, 2017). The determination of contingent shares being objective and ascertainable hardly becomes impossible to satisfy. Again, demanding one to state the maximum number of shares issuable under the contingency stock rights may lead to understatement. Such requirement by the revenue procedure leaves the inclusion of additional shares issued beyond the ascertained amount uncertain to qualify for tax-free status.

The strict aspect of immediate after exchanges makes Section 351 appear missing relevant elements in the determination appear conditioned. IRS Revenue Procedure misses the inclusion of escrowed stock options in the exchange process. Occasionally, the parties may escrow stock rather than distribute contingent stock rights. The stance adopted by IRC leaves escrowed stock option uncertain though of equal status of conditioned issuance as contingent stock rights. Although providing for actual stock issuances, IRS overlooks its treatment despite situations where its ownership by transferors of property serves a valid purpose of eighty percent control required by Section 351 (Dickinson, 2009). Like contingent stock rights, IRS should consider them to constitute stock in the ascertainment of eighty percent control. The inclusion of escrowed stock in the company records and books indicative of transferors ownership makes them effective for eighty percent control. Instead, IRS requires proof of ownership of escrowed stock by existing shareholder (Smith, 2009). Notwithstanding, the exclusion of shareholders control on events that may trigger issuance of stock escrowed replicates the scenario experienced in contingent stock rights. The requirement lacks clarity since it becomes impractical to overlook shareholders decisions in the issuances.

Security Interpretation

Formulations by tax courts serve an important input to resolve the controversy surrounding the relevance of securities interpretation within Section 351 purposes. The challenge arises the struggle to determine what constitutes securities and stock received as the exchange for property and monetary contribution under Section 351 purposes. The court's formulation showed relevance application to ascertain the bounds of security concept in Camp Wolters Enterprises v Commissioner (1954). The court held notes maturing as installments from the fifth till the ninth years since issuance securities that met Section 351 purposes (Cartano, 2008). The court decried to focus on the time, instead evaluated the notes based upon the nature of debts, participation degree, and purpose for its advancement. The interpretation held by the court shows the obligation term being the critical factor to ascertain its classification as security.

The application of Section 351 purpose shows consideration of multiple factors to determine relevant obligations. It indicates that existence of long-term hardly guarantees the absence of the dispute over obligations. IRS considers obligations being securities where they have relatively long terms. However, the commissioner has lost on such extremes evident in Deniss v Commissioner (1971), and Nye v Commissioner (1952) was a ten-year-term note was considered security. However, categorizing obligations carrying terms that run less than thirty months not securities is equivalently held by the court. In Adams V Commissioner (1972), the court held the note with a twenty-seven months term, not security. Such feeds into the controversy where obligations whose terms run below five years are not considered securities. Nevertheless, the formulations by the tax court show variant interpretation indicating multiple factors considered as relevant (Martin D. Ginsburg, 2012). Such emerged in Mills v U.S (1968) it disregarded an unsecured promissory note carrying a one-year term to satisfy the securities properties under Sections 351. The court supported the IFS position that obligations that carry terms below two years are not securities citing its six-month maturity term (Cartano, 2008). The remand of the case saw the court consider the issuance of notes served an integral purpose to delay issuance of preferred stock, hence qualified their treatment as securities.

Assumed Liability

The variant interpretation of assumed liability shows them being the biggest trap to ascertain Section 351 purpose....

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Research Paper on Section 351. (2022, May 12). Retrieved from

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