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Background

Mickey, Mickayla, and Taylor are starting a new business (MMT). To get the
business started, Mickey is contributing $200,000 for a 40 percent ownership
interest, Mickalya is contributing a building with a value of $200,000 and a
tax basis of $150,000 for a 40 percent ownership interest, and Taylor is
contributing legal services for a 20 percent ownership interest.
Assignment Requirements
How should these three form their business? Prepare a memo (not to exceed
2 pages) to MMT explaining your recommendation. Support your
recommendation with any applicable regulations, calculations, etc.

There are two ways to form or contribute to a new entity, either by transferring cash or property
to exchange for its stock. If property transfer is considered as the sale of property in return for
cash, the transaction is taxable. In that situation, the difference between the stock value received
and the tax basis in the property transferred will result in a gain or loss which will be taxed.
However, in order to support the new established entity, Congress enacted IRC section 351 and
section 721 to provide treatments for non-recognition of any gain. Such treatments allow entity
deferred any immediate tax consequence resulting from the exchange of property for stock until a
future time, such as when the stock received in the exchange was eventually disposed of by the
shareholder.
Under section 351, no gain or loss is recognized if there is a transfer of property - not service,
which is solely in exchange for corporate stock, and after the exchange the contributing
shareholder(s) is (are) in control of the corporation. Control is exercised when the ownership of
stock possessing at least 80% of the total combined voting power and at least 80% of the total
number of outstanding shares. Section 351 is applied for corporations, such as C corporation and
S corporation, while Section 721 is applied for partnership. The significant difference between
the two is there is no control requirement to get tax-free treatment for an LLC.
If an individual, along with others, transfer property into an entity, their group is referred to a
transferor group, and can apply treatments of non-recognition of any gain. Therefore, MMT, a
new business formed by Mickey, Mickayla, and Taylor with Mickalya's contribution of a
building can be referred to a transferor group.

MEMO
From: XYZ, Tax Consulting
To: Mickey, Mickayla, and Taylor
Subject: Consulting on MMT's form of business

Dear Mickey, Mickayla, and Taylor,


In reference to IRC section 351 and section 721, I would like to analyze the three forms of
business which you may form and its tax consequences.
a-/ MMT is formed as a C corporation or S corporation
Under section 351, Mickey and Mickayla's interests (40% each) are combined in meeting the
80% test, and thus do not recognize any gain. However, as Taylor contributes services, not
property, he does not get tax-free treatment and has to recognize $100,000 worth of stock he
receives from MMT (20% interest) as ordinary income.
b-/ MMT is formed as an LLC
Under section 721, Mickey and Mickayla do not recognize any gain on the transfer, regardless of
their interest. Taylor, however, still does not get tax-free treatment and has to recognize $100,000
worth of stock he receives from MMT as ordinary income because he contributes services, not
property.
As such, there will be no concern regarding the gain of your property transferred. The decision to
choose which form of business depends on other factors, both tax and non tax. Regarding non tax

characteristics, corporations and LLCs have the advantage in liability protection, LLCs and
partnerships have an advantage over other entities in terms of legal flexibility, and corporations
have the advantage if owners ever want to take a business public. Although tax factor such as the
double taxation associated with C corporations is important to consider, you must carefully
balance the tax and nontax characteristics unique to your entity.
Regards,