Tax-Free Contribution to Corporation in Exchange for Stock

When a person owns stock, they have a share of ownership in a company and are entitled to a share of the company’s assets or earnings. The more stock an individual owns, the more assets or earnings they are owed.

As the name suggests, common stock is the most common type of stock. This type of stock is considered the riskiest of investments but provides the stockholder with a certain amount of voting rights. These rights may be used to vote on certain corporate decisions, such as the election of the board of directors. Preferred stock is similar to common stock in that it gives the stockholder ownership in a company. However, it does not generally provide the same voting rights.

The difference between preferred and common stock would be that common stock has variable returns, while preferred stock has a guaranteed fixed dividend. A preferred shareholder will receive payment before a common shareholder in the event of a company liquidation. The stock is also callable, meaning the company may repurchase it at any time and for any reason. Most companies will divide their stock into different classes designated by letters. This is done to keep voting rights isolated to a particular group.

Stock prices may change based on the economic concept of supply and demand. This means that the more stock is purchased, the higher the stock price increases. The inverse is also true; the less the stock is purchased, the more the price will decrease. The demand for a stock is generally affected by what investors believe the company is worth.

A stock is a type of security. Securities also include:

• Bonds;
• Debentures; and
• Other interests involve an investment with a return that is primarily or exclusively dependent on the efforts of someone other than the investor.

Securities, or stock laws, are the federal laws and regulations that govern the purchase, sale, and creation of a security interest. These laws derive from the concept that all investors, whether large institutions or private individuals, should have access to basic information about an investment before making their purchase.

Securities laws are enforced in the United States by the Securities and Exchange Commission or the “SEC.” The SEC is charged with protecting investors and maintaining the securities markets’ integrity by requiring public companies to disclose meaningful financial and other information to the public. This is so that their securities investments can be evaluated.

The terms stock, equity, or shares all refer to ownership in a company. Equity refers to ownership of assets after the debt is paid, while stock refers to traded equity representing an equity investment. How much power a stockholder has largely depends on how many shares the stockholder owns. Generally speaking, unless they are an institutional investor, a single person does not have much of a say in the company’s day-to-day operations. Their control is limited to the election or removal of board directors, as previously mentioned.

What Is Corporate Tax?

A corporate tax, also known as a corporation or company tax, is a type of fee the federal government imposes on a business’s profits. According to the Federal Tax Cuts and Jobs Act of 2017, the current federal corporate tax rate is 21%. After all business expenses have been deducted, a corporation will be required to pay the federal government 21% of its total revenue when filing a federal corporate tax return.

An example of this would be if your corporation made $1 million in revenue after deducting all legitimate business expenses. When you file your business’s federal corporate tax return, you will owe 21% of that $1 million in taxes to the federal government, or $210,000.

It is important to note that the federal corporate tax rate is subject to change. Additionally, states may impose their own separate corporate income tax rates on top of the federal corporate tax. However, not every state applies a state corporate income tax rate, and those generally have rates that vary widely based on jurisdiction. The standard range for state corporate income tax rates is between 1-12%, with most state rates averaging somewhere in the middle.

Do I Need To Recognize Any Income If I Contribute Money In Exchange For Stock When I Form A Corporation?

Generally speaking, no. No gain or loss is recognized by the taxpayer or a group of taxpayers when the taxpayer transfers property to a corporation solely in exchange for stock in such corporation. The other instance would be immediately after the exchange, and the taxpayer is in “control” of such a corporation.

However, this rule does not apply if the corporation is an investment company. An example of this would be a corporation that holds and sells stocks as investments. In terms of who the tax-free contribution rule applies to, the following are included:

• Individuals;
• Trusts;
• Estates;
• Partnerships; and
• Other Corporations.

If I Only Provide Personal Services In Exchange For Stock, Would That Qualify For Tax-Free Contribution Treatment?

In short, no. Property, and not services, must be transferred to the corporation in order for the tax-free treatment to apply. There are generally three things that are not considered to be property for the purposes of this tax-free contribution rule:

1. Services;
2. Unsecured loan of the corporation; and
3. Accrued and unpaid interest on a loan of the corporation.

If corporate stock is issued in exchange for the contribution of the above items, the exchange will not qualify for tax-free treatment.

What Is “Control” For The Purposes Of This Tax-Free Contribution Rule?

Generally speaking, “control” means that after the transfer of property, the taxpayer has at least 80% of the total combined voting power of all classes of stock entitled to vote. Control also means that after the property transfer, the taxpayer has at least 80% of the total number of all other classes of stock. Control does not require the taxpayer to have actual control over the affairs of the corporation, meaning the daily operations; rather, it only refers to the corporation’s ownership.

Will My Transaction Be Disqualified From Tax-Free Contribution Treatment If I Receive Property Other Than Stock From A Corporation?

When taxpayers receive property other than stock in this exchange, they may still enjoy partial tax-free treatment on the transfer. Gain from the exchange, such as if the fair market value of the stock received exceeds the basis of the property transferred, must be recognized to the extent of:

• The amount of cash received, plus
• The fair market value of other property received.

No loss is recognized by the taxpayer for this type of transfer, even if property other than stock is received from the corporation.

Do I Need A Tax Attorney?

If you have questions about how to organize your corporation tax-free or if you need someone to represent you before the IRS, a tax attorney in your area can help you. A tax attorney will help you understand your legal rights and options and the varying tax laws that may apply to you.

Tax laws can be complex and may also be subject to frequent change. A local tax lawyer will be able to provide guidance on any new legal changes that might affect your rights.